Table of Contents


 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2017
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to ____________
 
Commission file number: 0-12247
SOUTHSIDE BANCSHARES, INC.
(Exact name of registrant as specified in its charter)

TEXAS
 
75-1848732
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
1201 S. Beckham Avenue, Tyler, Texas
 
75701
(Address of principal executive offices)
 
(Zip Code)
903-531-7111
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes   x     No   o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes   x     No   o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x
Accelerated filer o
Non-accelerated filer o
(Do not check if a smaller reporting company)
 
Smaller reporting company o
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o   No  x
The number of shares of the issuer’s common stock, par value $1.25, outstanding as of April 24, 2017 was 28,586,916 shares.
 


TABLE OF CONTENTS
 
PART I.  FINANCIAL INFORMATION
 
PART II.  OTHER INFORMATION
 

Table of Contents


PART I.   FINANCIAL INFORMATION
ITEM 1.   FINANCIAL STATEMENTS
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(in thousands, except share amounts)
 
 
March 31,
2017
 
December 31,
2016
ASSETS
 
 
 
 
Cash and due from banks
 
$
54,345

 
$
59,363

Interest earning deposits
 
185,289

 
102,251

Federal funds sold
 
7,360

 
8,040

Total cash and cash equivalents
 
246,994

 
169,654

Securities available for sale, at estimated fair value
 
1,444,043

 
1,479,600

Securities held to maturity, at carrying value (estimated fair value of $940,409 and $944,282, respectively)
 
929,793

 
937,487

FHLB stock, at cost
 
61,305

 
61,084

Other investments
 
5,442

 
5,508

Loans held for sale
 
5,303

 
7,641

Loans:
 
 

 
 

Loans
 
2,538,918

 
2,556,537

Less:  Allowance for loan losses
 
(18,485
)
 
(17,911
)
Net Loans
 
2,520,433

 
2,538,626

Premises and equipment, net
 
105,327

 
106,003

Goodwill
 
91,520

 
91,520

Other intangible assets, net
 
4,177

 
4,608

Interest receivable
 
18,273

 
25,183

Deferred tax asset, net
 
26,827

 
28,891

Unsettled trades to sell securities
 
57,385

 
—

Unsettled issuances of brokered certificates of deposit
 
31,232

 
—

Bank owned life insurance
 
98,377

 
97,775

Other assets
 
9,818

 
10,187

Total assets
 
$
5,656,249

 
$
5,563,767

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 

 
 

Deposits:
 
 

 
 

Noninterest bearing
 
$
753,224

 
$
704,013

Interest bearing
 
2,952,072

 
2,829,063

Total deposits
 
3,705,296

 
3,533,076

Short-term obligations:
 
 

 
 

Federal funds purchased and repurchase agreements
 
7,814

 
7,097

FHLB advances
 
952,916

 
866,518

Total short-term obligations
 
960,730

 
873,615

Long-term obligations:
 
 

 
 

FHLB advances
 
252,940

 
443,128

Subordinated notes, net of unamortized debt issuance costs
 
98,133

 
98,100

Long-term debt, net of unamortized debt issuance costs
 
60,237

 
60,236

Total long-term obligations
 
411,310

 
601,464

Unsettled trades to purchase securities
 
10,465

 
160

Other liabilities
 
36,982

 
37,178

Total liabilities
 
5,124,783

 
5,045,493

 
 
 
 
 
Off-balance-sheet arrangements, commitments and contingencies (Note 11)
 


 


 
 
 
 
 
Shareholders’ equity:
 
 

 
 

Common stock ($1.25 par value, 40,000,000 shares authorized, 31,499,980 shares issued at March 31, 2017 and 31,455,951 shares issued at December 31, 2016)
 
39,375

 
39,320

Paid-in capital
 
536,653

 
535,240

Retained earnings
 
37,920

 
30,098

Treasury stock, at cost (2,913,064 shares at March 31, 2017 and December 31, 2016)
 
(47,891
)
 
(47,891
)
Accumulated other comprehensive loss
 
(34,591
)
 
(38,493
)
Total shareholders’ equity
 
531,466

 
518,274

Total liabilities and shareholders’ equity
 
$
5,656,249

 
$
5,563,767


The accompanying notes are an integral part of these consolidated financial statements.

1
Table of Contents


SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(in thousands, except per share data)
 
Three Months Ended
 
March 31,
 
2017
 
2016
Interest income
 
 
 
Loans
$
27,254

 
$
27,765

Investment securities – taxable
377

 
214

Investment securities – tax-exempt
6,554

 
5,355

Mortgage-backed securities
10,045

 
9,391

FHLB stock and other investments
298

 
217

Other interest earning assets
360

 
70

Total interest income
44,888

 
43,012

Interest expense
 

 
 

Deposits
4,281

 
3,256

Short-term obligations
2,065

 
696

Long-term obligations
3,262

 
2,444

Total interest expense
9,608

 
6,396

Net interest income
35,280

 
36,616

Provision for loan losses
1,098

 
2,316

Net interest income after provision for loan losses
34,182

 
34,300

Noninterest income
 

 
 

Deposit services
5,114

 
5,085

Net gain on sale of securities available for sale
322

 
2,441

Gain on sale of loans
701

 
643

Trust income
890

 
855

Bank owned life insurance income
634

 
674

Brokerage services
547

 
575

Other
1,465

 
1,323

Total noninterest income
9,673

 
11,596

Noninterest expense
 

 
 

Salaries and employee benefits
15,919

 
17,732

Occupancy expense
2,863

 
3,335

Advertising, travel & entertainment
583

 
685

ATM and debit card expense
927

 
712

Professional fees
939

 
1,338

Software and data processing expense
725

 
749

Telephone and communications
526

 
484

FDIC insurance
441

 
638

Other
2,935

 
3,734

Total noninterest expense
25,858

 
29,407

 
 
 
 
Income before income tax expense
17,997

 
16,489

Income tax expense
3,008

 
2,973

Net income
$
14,989

 
$
13,516

Earnings per common share – basic
$
0.52

 
$
0.51

Earnings per common share – diluted
$
0.52

 
$
0.51

Dividends paid per common share
$
0.25

 
$
0.23


The accompanying notes are an integral part of these consolidated financial statements.

2
Table of Contents


SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
(in thousands)
 
Three Months Ended

March 31,
 
2017
 
2016
Net income
$
14,989

 
$
13,516

Other comprehensive income:
 

 
 

Securities available for sale and transferred securities:
 
 
 
Change in net unrealized holding gains on available for sale securities during the period
4,885

 
27,744

Reclassification adjustment for amortization of unrealized losses on securities transferred to held to maturity
488

 
57

Reclassification adjustment for net gain on sale of available for sale securities, included in net income
(322
)
 
(2,441
)
Derivatives:
 
 
 
Change in net unrealized loss on effective cash flow hedge interest rate swap derivatives
(80
)
 
(2,601
)
Change in net unrealized gains on interest rate swap derivatives terminated during the period
273

 
—

Reclassification adjustment for net loss on interest rate swap derivatives, included in net income
379

 
357

Reclassification adjustment for amortization of unrealized gains on terminated interest rate swap derivatives
(9
)
 
—

Pension plans:
 
 
 
Amortization of net actuarial loss, included in net periodic benefit cost
391

 
411

Amortization of prior service credit, included in net periodic benefit cost
(2
)
 
(4
)
Other comprehensive income, before tax
6,003

 
23,523

Income tax expense related to items of other comprehensive income
(2,101
)
 
(8,233
)
Other comprehensive income, net of tax
3,902

 
15,290

Comprehensive income
$
18,891

 
$
28,806


The accompanying notes are an integral part of these consolidated financial statements.

3
Table of Contents


SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(UNAUDITED)
(in thousands, except share and per share data)
 
Common
Stock
 
Paid In
Capital
 
Retained
Earnings
 
Treasury
Stock
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total
Shareholders’
Equity
Balance at December 31, 2015
$
34,832

 
$
424,078

 
$
41,527

 
$
(37,692
)
 
$
(18,683
)
 
$
444,062

Net income
—

 
—

 
13,516

 
—

 
—

 
13,516

Other comprehensive income
—

 
—

 
—

 
—

 
15,290

 
15,290

Issuance of common stock for dividend reinvestment plan (12,030 shares)
15

 
299

 
—

 
—

 
—

 
314

Purchase of common stock (443,426 shares)
—

 
—

 
—

 
(10,199
)
 
—

 
(10,199
)
Stock compensation expense
—

 
355

 
—

 
—

 
—

 
355

Tax expense related to stock awards
—

 
(12
)
 
—

 
—

 
—

 
(12
)
Net issuance of common stock under employee stock plans (4,912 shares)
6

 
33

 
(15
)
 
—

 
—

 
24

Cash dividends paid on common stock ($0.23 per share)
—

 
—

 
(5,774
)
 
—

 
—

 
(5,774
)
Balance at March 31, 2016
$
34,853

 
$
424,753

 
$
49,254

 
$
(47,891
)
 
$
(3,393
)
 
$
457,576

 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
$
39,320

 
$
535,240

 
$
30,098

 
$
(47,891
)
 
$
(38,493
)
 
$
518,274

Net income
—

 
—

 
14,989

 
—

 
—

 
14,989

Other comprehensive income
—

 
—

 
—

 
—

 
3,902

 
3,902

Issuance of common stock for dividend reinvestment plan (10,433 shares)
13

 
340

 
—

 
—

 
—

 
353

Stock compensation expense
—

 
494

 
—

 
—

 
—

 
494

Net issuance of common stock under employee stock plans (33,596 shares)
42

 
579

 
(24
)
 
—

 
—

 
597

Cash dividends paid on common stock ($0.25 per share)
—

 
—

 
(7,143
)
 
—

 
—

 
(7,143
)
Balance at March 31, 2017
$
39,375

 
$
536,653

 
$
37,920

 
$
(47,891
)
 
$
(34,591
)
 
$
531,466


The accompanying notes are an integral part of these consolidated financial statements.

4
Table of Contents


SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED)
(in thousands)
 
Three Months Ended
 
March 31,
 
2017
 
2016
OPERATING ACTIVITIES:
 
 
 
Net income
$
14,989

 
$
13,516

Adjustments to reconcile net income to net cash provided by operations:
 

 
 

Depreciation and net amortization
2,417

 
2,169

Securities premium amortization (discount accretion), net
4,567

 
4,510

Loan (discount accretion) premium amortization, net
(290
)
 
(799
)
Provision for loan losses
1,098

 
2,316

Stock compensation expense
494

 
355

Deferred tax benefit
(19
)
 
(812
)
Net tax (expense) benefit related to stock awards
—

 
12

Net gain on sale of securities available for sale
(322
)
 
(2,441
)
Net gain on premises and equipment
—

 
(19
)
Gross proceeds from sales of loans held for sale
22,521

 
17,944

Gross originations of loans held for sale
(20,183
)
 
(19,104
)
Net loss on other real estate owned
—

 
152

Net change in:
 

 
 

Interest receivable
6,910

 
6,152

Other assets
7,419

 
590

Interest payable
(1,523
)
 
291

Other liabilities
(5,377
)
 
1,243

Net cash provided by operating activities
32,701

 
26,075

 
 
 
 
INVESTING ACTIVITIES:
 

 
 

Securities available for sale:
 
 
 
Purchases
(139,246
)
 
(135,648
)
Sales
99,653

 
251,976

Maturities, calls and principal repayments
29,770

 
47,407

Securities held to maturity:
 

 
 

Purchases
(1,521
)
 
(18,922
)
Maturities, calls and principal repayments
8,305

 
5,168

Proceeds from redemption of FHLB stock and other investments
81

 
3,644

Purchases of FHLB stock and other investments
(221
)
 
(171
)
Net loans originated
17,201

 
(11,420
)
Purchases of premises and equipment
(1,287
)
 
(1,648
)
Proceeds from sales of premises and equipment
3

 
50

Proceeds from sales of other real estate owned
—

 
483

Proceeds from sales of repossessed assets
179

 
311

Net cash provided by investing activities
12,917

 
141,230

 
 
 
 
(continued)
 
 
 

5
Table of Contents



SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED) (continued)
(in thousands)
 
Three Months Ended
 
March 31,
 
2017
 
2016
FINANCING ACTIVITIES:
 
 
 
Net change in deposits
$
140,978

 
$
164,249

Net increase in federal funds purchased and repurchase agreements
717

 
72

Proceeds from FHLB advances
725,000

 
2,916,882

Repayment of FHLB advances
(828,780
)
 
(3,245,382
)
Tax expense related to stock awards
—

 
(12
)
Proceeds from stock option exercises
639

 
35

Cash paid to tax authority from stock option exercises
(42
)
 
(11
)
Purchase of common stock
—

 
(10,199
)
Proceeds from the issuance of common stock for dividend reinvestment plan
353

 
314

Cash dividends paid
(7,143
)
 
(5,774
)
Net cash provided by (used in) financing activities
31,722

 
(179,826
)
 
 
 
 
Net increase (decrease) in cash and cash equivalents
77,340

 
(12,521
)
Cash and cash equivalents at beginning of period
169,654

 
80,975

Cash and cash equivalents at end of period
$
246,994

 
$
68,454

 
 
 
 
SUPPLEMENTAL DISCLOSURES FOR CASH FLOW INFORMATION:
 

 
 


 
 
 
Interest paid
$
11,131

 
$
6,104

Income taxes paid
$
—

 
$
—

 
 
 
 
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
 

 
 


 
 
 
Loans transferred to other repossessed assets and real estate through foreclosure
$
184

 
$
465

Adjustment to pension liability
$
(389
)
 
$
(407
)
Unsettled trades to purchase securities
$
(10,465
)
 
$
(23,920
)
Unsettled trades to sell securities
$
57,385

 
$
15,039

Unsettled issuances of brokered CDs
$
31,232

 
$
—


The accompanying notes are an integral part of these consolidated financial statements.


6
Table of Contents


SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.     Summary of Significant Accounting and Reporting Policies

Basis of Presentation
In this report, the words “the Company,” “we,” “us,” and “our” refer to the combined entities of Southside Bancshares, Inc. and its subsidiaries.  The words “Southside” and “Southside Bancshares” refer to Southside Bancshares, Inc.  The words “Southside Bank” and “the Bank” refer to Southside Bank. “Omni” refers to OmniAmerican Bancorp, Inc., a bank holding company acquired by Southside on December 17, 2014.
The consolidated balance sheet as of March 31, 2017 , and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, cash flows and notes to the financial statements for the three- month periods ended March 31, 2017 and 2016 are unaudited; in the opinion of management, all adjustments necessary for a fair presentation of such financial statements have been included.  Such adjustments consisted only of normal recurring items.  All intercompany accounts and transactions are eliminated in consolidation.  The preparation of these consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires the use of management’s estimates.  These estimates are subjective in nature and involve matters of judgment.  Actual amounts could differ from these estimates.
Interim results are not necessarily indicative of results for a full year.  These financial statements should be read in conjunction with the financial statements and notes thereto in our Annual Report on Form 10-K for the year ended December 31, 2016 .  
Accounting Changes and Reclassifications
Certain prior period amounts have been reclassified to conform to current year presentation.
We adopted ASU 2016-09 “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting,” on January 1, 2017 which requires all income tax effects related to settlements of share-based payment awards be reported in earnings as an increase (or decrease) to income tax expense. Previously, income tax benefits at settlement of an award were reported as an increase (or decrease) to additional paid-in capital to the extent that those benefits were greater than (or less than) the income tax benefits recognized in earnings during the vesting period or exercise of the award. The requirement to report those income tax effects in earnings has been applied to settlements occurring on or after January 1, 2017, and the impact of applying that guidance reduced reported income tax expense by $126,000 , or less than $0.01 on our diluted earnings per common share. ASU 2016-09 also requires that all income tax-related cash flows resulting from share-based payments be reported as operating activities in the statement of cash flows. Previously, income tax benefits at settlement of an award were reported as a reduction to operating cash flows and an increase to financing cash flows to the extent that those benefits exceeded the income tax benefits reported in earnings during the vesting period or exercise of the award. We have elected to apply that change in cash flow on a prospective basis and therefore, prior periods have not been adjusted. ASU 2016-09 also requires the classification of employee taxes paid when an employer withholds shares for tax withholding purposes be classified as a financing activity in the statement of cash flow and be applied retrospectively. The requirement to report the employee taxes paid is reflected in prior period presentation in our consolidated statement of cash flows. In connection with the adoption of ASU 2016-09, we have also elected to recognize forfeitures as they occur.
Terminated Derivative Financial Instruments
In accordance with ASC Topic 815, if a hedging item is terminated prior to maturity for a cash settlement, the existing gain or loss within accumulated other comprehensive income will continue to be reclassified into earnings during the period or periods in which the hedged forecasted transaction affects earnings unless it is probable that the forecasted transaction will not occur by the end of the originally specified time period. If the forecasted transaction is deemed probable to not occur, the derivative gain or loss reported in accumulated other comprehensive income shall be reclassified into earnings immediately. During the first quarter of 2017, we terminated two interest rate swap contracts designated as cash flow hedges. At the time of termination, we determined that the underlying hedged forecasted transactions were still probable of occurring. The existing gain in accumulated other comprehensive income related to the terminated interest rate swap contracts will be reclassified into earnings through straight-line accretion in the same periods the hedged forecasted transaction affects earnings.
Further information on our derivative instruments and hedging activities is included in “Note 8 - Derivative Financial Instruments and Hedging Activities.”
For a description of our significant accounting and reporting policies, refer to “Note 1- Summary of Significant Accounting and Reporting Policies” in our consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2016 .

7


Accounting Pronouncements
In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606).”  This update states that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  This update affects entities that enter into contracts with customers to transfer goods or services or enter into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards. In August 2015, the FASB issued ASU 2015-14, “Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date,” which effectively delayed the adoption date by one year. We are required to adopt ASU 2014-09 in the first quarter of fiscal 2018. Early adoption is permitted. The guidance permits companies to either apply the requirements retrospectively to all prior periods presented, or apply the requirements in the year of adoption, through cumulative adjustment.  Our revenue consists of net interest income on financial assets and financial liabilities, which is explicitly excluded from the scope of ASU 2014-09, and noninterest income.  We are currently evaluating the impact this guidance will have in relation to our noninterest income derived from contracts with our customers as it relates to deposit services, trust income, brokerage services, and merchant services (included in other noninterest income) which we have determined to be in the scope of ASU 2014-09.  We anticipate our assessment for these areas to be completed during the second quarter of 2017 at which time we will select the transition method to be applied upon adoption.  We are concurrently evaluating the impact and resources needed to fulfill the additional disclosures required by this guidance.
In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842).” ASU 2016-02 requires a lessee to recognize assets and liabilities for leases with lease terms of more than 12 months. Consistent with current GAAP, the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or operating lease. However, unlike current GAAP which requires only capital leases to be recognized on the balance sheet, the new ASU 2016-02 will require both finance (formerly known as “capital”) and operating leases to be recognized on the balance sheet. ASU 2016-02 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted. The guidance requires companies to apply the requirements in the year of adoption using a modified retrospective approach. We are currently evaluating the impact this guidance will have on our financial statements and we anticipate our assessment to be completed during the fiscal year 2018. 
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. ASU 2016-13 also modifies the impairment model for available for sale debt securities and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination. ASU 2016-13 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The guidance requires companies to apply the requirements in the year of adoption through cumulative adjustment with some aspects of the update requiring a prospective transition approach. We are currently evaluating the potential impact of the pending adoption of ASU 2016-13 on our consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04, “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” ASU 2017-04 is intended to simplify goodwill impairment testing by eliminating the second step of the analysis which requires the calculation of the implied fair value of goodwill to measure a goodwill impairment charge. The update requires entities to compare the fair value of a reporting unit with its carrying amount and recognize an impairment charge for any amount by which the carrying amount exceeds the reporting unit’s fair value, to the extent that the loss recognized does not exceed the amount of goodwill allocated to that reporting unit. ASU 2017-04 is effective for annual and interim goodwill impairment tests performed in periods beginning after December 15, 2019. Early adoption is permitted for annual and interim goodwill impairment testing dates after January 1, 2017. The guidance requires companies to apply the requirements prospectively in the year of adoption. ASU 2017-04 is not expected to have a significant impact on our consolidated financial statements.
In March 2017, the FASB issued ASU 2017-07, “Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.” ASU 2017-07 requires employers to present the service cost component of net periodic benefit cost in the same income statement line item as other employee compensation costs arising from services rendered during the period. Only the service cost component will be eligible for capitalization in assets. Employers are required to present the other components of the net periodic benefit cost separately from the line item that includes the service cost and outside of any subtotal of operating income, if one is presented. ASU 2017-07 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted as of the beginning of an annual period for which financial statements (interim or annual) have not been issued or made available for issuance. We did not early adopt. The guidance requires companies to apply the requirements retrospectively to all prior periods presented. We are currently evaluating the potential impact of the pending adoption of ASU 2017-07 on our consolidated financial statements.
In March 2017, the FASB issued ASU 2017-08, “Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities.” Under current GAAP, premiums on callable debt securities are generally amortized over the contractual life of the security. ASU 2017-08 requires the premium on callable debt securities to be amortized

8


to the earliest call date. If the debt security is not called at the earliest call date, the holder of the debt security would be required to reset the effective yield on the debt security based on the payment terms required by the debt security. ASU 2017-08 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted. The guidance requires companies to apply the requirements on a modified retrospective basis through a cumulative adjustment directly to retained earnings as of the beginning of the period of adoption. We are currently evaluating the potential impact of the pending adoption of ASU 2017-08 on our consolidated financial statements.

2.      Earnings Per Share
Earnings per share on a basic and diluted basis has been adjusted to give retroactive recognition to stock dividends and is calculated as follows (in thousands, except per share amounts):
 
Three Months Ended
March 31,
 
2017
 
2016
Basic and Diluted Earnings:
 
 
 
Net income
$
14,989

 
$
13,516

Basic weighted-average shares outstanding
28,569

 
26,449

Add:   Stock awards
208

 
70

Diluted weighted-average shares outstanding
28,777

 
26,519

 
 

 
 

Basic Earnings Per Share:
 
 
 
Net Income
$
0.52

 
$
0.51

Diluted Earnings Per Share:
 
 
 
Net Income
$
0.52

 
$
0.51

For the three- month periods ended March 31, 2017 and 2016 , there were approximately 52,000 and 112,000 antidilutive shares, respectively.

9


3.      Accumulated Other Comprehensive Income (Loss)

The changes in accumulated other comprehensive income (loss) by component are as follows (in thousands):

 
Three Months Ended March 31, 2017
 

 
 
Pension Plans
 
 
 
Unrealized Gains (Losses) on Securities
 
Unrealized Gains (Losses) on Derivatives
 
Net Prior
Service
(Cost)
Credit
 
Net Gain (Loss)
 
Total
Beginning balance, net of tax
$
(23,708
)
 
$
4,595

 
$
(133
)
 
$
(19,247
)
 
$
(38,493
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
Other comprehensive income before reclassifications
4,885

 
193

 
—

 
—

 
5,078

Reclassified from accumulated other comprehensive income
166

 
370

 
(2
)
 
391

 
925

Income tax (expense) benefit
(1,768
)
 
(197
)
 
1

 
(137
)
 
(2,101
)
Net current-period other comprehensive income (loss), net of tax
3,283

 
366

 
(1
)
 
254

 
3,902

Ending balance, net of tax
$
(20,425
)
 
$
4,961

 
$
(134
)
 
$
(18,993
)
 
$
(34,591
)

 
Three Months Ended March 31, 2016
 

 
 
Pension Plans
 
 
 
Unrealized Gains (Losses) on Securities
 
Unrealized Gains (Losses) on Derivatives
 
Net Prior
 Service
 (Cost)
 Credit
 
Net Gain (Loss)
 
Total
Beginning balance, net of tax
$
(239
)
 
$
—

 
$
(44
)
 
$
(18,400
)
 
$
(18,683
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
Other comprehensive income (loss) before reclassifications
27,744

 
(2,601
)
 
—

 
—

 
25,143

Reclassified from accumulated other comprehensive income
(2,384
)
 
357

 
(4
)
 
411

 
(1,620
)
Income tax (expense) benefit
(8,876
)
 
785

 
1

 
(143
)
 
(8,233
)
Net current-period other comprehensive income (loss), net of tax
16,484

 
(1,459
)
 
(3
)
 
268

 
15,290

Ending balance, net of tax
$
16,245

 
$
(1,459
)
 
$
(47
)
 
$
(18,132
)
 
$
(3,393
)

10


The reclassifications out of accumulated other comprehensive income (loss) into net income are presented below (in thousands):
 
Three Months Ended
March 31,
 
2017
 
2016
 
 
 
 
Unrealized losses on securities transferred to held to maturity:
 
 
 
Amortization of unrealized losses (1)
$
(488
)
 
$
(57
)
Tax benefit
171

 
20

Net of tax
$
(317
)
 
$
(37
)
 
 
 
 
Unrealized gains and losses on available for sale securities:
 
 
 
Realized net gain on sale of securities (2)
$
322

 
$
2,441

Tax expense
(113
)
 
(854
)
Net of tax
$
209

 
$
1,587

 
 
 
 
Derivatives:
 
 
 
Realized net loss on interest rate swap derivatives (3)
$
(379
)
 
$
(357
)
Tax benefit
133

 
125

Net of tax
$
(246
)
 
$
(232
)
 
 
 
 
Amortization of unrealized gains on terminated interest rate swap derivatives (3)
$
9

 
$
—

Tax expense
(3
)
 
—

Net of tax
$
6

 
$
—

 
 
 
 
Amortization of pension plan:
 
 
 
Net actuarial loss (4)
$
(391
)
 
$
(411
)
Prior service credit (4)
2

 
4

Total before tax
(389
)
 
(407
)
Tax benefit
136

 
142

Net of tax
(253
)
 
(265
)
Total reclassifications for the period, net of tax
$
(601
)
 
$
1,053

(1)    Included in interest income on the consolidated statements of income.
(2)    Listed as net gain on sale of securities available for sale on the consolidated statements of income.
(3)    Included in interest expense for long-term obligations on the consolidated statements of income.
(4)
These accumulated other comprehensive income components are included in the computation of net periodic pension cost (income) presented in “Note 7 - Employee Benefit Plans.”

11


4.      Securities

The amortized cost, gross unrealized gains and losses, carrying value, and estimated fair value of investment and mortgage-backed securities as of March 31, 2017 and December 31, 2016 are reflected in the tables below (in thousands):
 
 
March 31, 2017
 
 
 
 
Recognized in OCI
 
 
 
Not recognized in OCI
 
 

 
Amortized
 
Gross
Unrealized
 
Gross Unrealized
 
Carrying
 
Gross
Unrealized
 
Gross Unrealized
 
Estimated
AVAILABLE FOR SALE
 
Cost
 
Gains
 
Losses
 
Value
 
Gains
 
Losses
 
Fair Value
Investment Securities:
 
 
 
 
 
 
 
 
 
 
 
 
 

U.S. Treasury
 
$
62,015

 
$
—

 
$
2,801

 
$
59,214

 
$
—

 
$
—

 
$
59,214

State and Political Subdivisions
 
328,395

 
3,227

 
10,775

 
320,847

 
—

 
—

 
320,847

Other Stocks and Bonds
 
6,574

 
84

 
—

 
6,658

 
—

 
—

 
6,658

Other Equity Securities
 
6,036

 
—

 
116

 
5,920

 
—

 
—

 
5,920

Mortgage-backed Securities: (1)
 
 

 
 

 
 

 
 
 
 
 
 
 
 
Residential
 
685,934

 
6,621

 
7,893

 
684,662

 
—

 
—

 
684,662

Commercial

368,330

 
896

 
2,484

 
366,742

 
—

 
—

 
366,742

Total
 
$
1,457,284

 
$
10,828

 
$
24,069

 
$
1,444,043

 
$
—

 
$
—

 
$
1,444,043

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
HELD TO MATURITY
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investment Securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
State and Political Subdivisions
 
$
430,350

 
$
3,631

 
$
12,848

 
$
421,133

 
$
8,902

 
$
2,747

 
$
427,288

Mortgage-backed Securities: (1)
 
 

 
 

 
 

 
 
 
 
 
 
 
 
Residential
 
137,693

 
—

 
5,478

 
132,215

 
1,536

 
370

 
133,381

Commercial
 
379,931

 
1,025

 
4,511

 
376,445

 
4,952

 
1,657

 
379,740

Total
 
$
947,974

 
$
4,656

 
$
22,837

 
$
929,793

 
$
15,390

 
$
4,774

 
$
940,409


12


 
 
December 31, 2016
 
 
 
 
Recognized in OCI
 
 
 
Not recognized in OCI
 
 
 
 
Amortized
 
Gross
Unrealized
 
Gross Unrealized
 
Carrying
 
Gross
Unrealized
 
Gross Unrealized
 
Estimated
AVAILABLE FOR SALE
 
Cost
 
Gains
 
Losses
 
Value
 
Gains
 
Losses
 
Fair Value
Investment Securities:
 
 
 
 
 
 
 
 

 
 
 
 
 
U.S. Treasury
 
$
74,016

 
$
—

 
$
3,947

 
$
70,069

 
$
—

 
$
—

 
$
70,069

State and Political Subdivisions
 
394,050

 
3,217

 
12,070

 
385,197


—

 
—

 
385,197

Other Stocks and Bonds
 
6,587

 
64

 
—


6,651


—

 
—

 
6,651

Other Equity Securities
 
6,039

 
—

 
119

 
5,920

 
—

 
—

 
5,920

Mortgage-backed Securities: (1)
 
 
 
 
 
 

 
 

 
 
 
 
 
Residential
 
630,603

 
6,434

 
9,529


627,508


—

 
—

 
627,508

Commercial

386,109


1,201


3,055


384,255


—

 
—

 
384,255

Total
 
$
1,497,404

 
$
10,916

 
$
28,720

 
$
1,479,600

 
$
—

 
$
—

 
$
1,479,600

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
HELD TO MATURITY
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investment Securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
State and Political Subdivisions
 
$
435,080

 
$
3,987

 
$
13,257

 
$
425,810

 
$
7,595

 
$
3,493

 
$
429,912

Mortgage-backed Securities: (1)
 
 

 
 

 
 

 
 
 
 
 
 
 
 

Residential
 
142,060

 
—

 
5,748

 
136,312

 
1,534

 
950

 
136,896

Commercial
 
379,016

 
1,067

 
4,718

 
375,365

 
4,372

 
2,263

 
377,474

Total
 
$
956,156

 
$
5,054

 
$
23,723

 
$
937,487

 
$
13,501

 
$
6,706

 
$
944,282


(1)
All mortgage-backed securities issued and/or guaranteed by U.S. government agencies or U.S. government-sponsored enterprises.

From time to time, we may transfer securities from available for sale (“AFS”) to held to maturity (“HTM”) due to overall balance sheet strategies. During 2016, the Company transferred securities with a fair value of $157.1 million from AFS to HTM. The unrealized loss on the securities transferred from AFS to HTM was $10.2 million ( $6.7 million , net of tax) at the date of transfer based on the fair value of the securities on the transfer date. Our management has the current intent and ability to hold the transferred securities until maturity. Any net unrealized gain or loss on the transferred securities included in accumulated other comprehensive income at the time of transfer will be amortized over the remaining life of the underlying security as an adjustment of the yield on those securities. AFS securities transferred with losses included in accumulated other comprehensive income continue to be included in management’s assessment for other-than-temporary impairment for each individual security. There were no securities transferred from AFS to HTM during the three months ended March 31, 2017 .





13


The following tables represent the estimated fair value and unrealized loss on securities as of March 31, 2017 and December 31, 2016 (in thousands):
 
As of March 31, 2017
 
Less Than 12 Months
 
More Than 12 Months
 
Total
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
AVAILABLE FOR SALE
 
 
 
 
 
 
 
 
 
 
 
Investment Securities:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
59,214

 
$
2,801

 
$
—

 
$
—

 
$
59,214

 
$
2,801

State and Political Subdivisions
209,637

 
10,774

 
886

 
1

 
210,523

 
10,775

   Other Equity Securities
5,920

 
116

 
—

 
—

 
5,920

 
116

Mortgage-backed Securities:
 
 
 
 
 
 
 
 
 
 
 
Residential
361,710

 
7,887

 
2,344

 
6

 
364,054

 
7,893

Commercial
248,331

 
2,484

 
—

 
—

 
248,331

 
2,484

Total
$
884,812

 
$
24,062

 
$
3,230

 
$
7

 
$
888,042

 
$
24,069

HELD TO MATURITY
 

 
 

 
 

 
 

 
 

 
 

Investment Securities:
 
 
 
 
 
 
 
 
 
 
 
State and Political Subdivisions
$
99,422

 
$
1,372

 
$
25,976

 
$
1,375

 
$
125,398

 
$
2,747

Mortgage-backed Securities:
 
 
 
 
 
 
 
 
 
 
 
Residential
55,917

 
370

 
—

 
—

 
55,917

 
370

Commercial
172,138

 
1,657

 
—

 
—

 
172,138

 
1,657

Total
$
327,477

 
$
3,399

 
$
25,976

 
$
1,375

 
$
353,453

 
$
4,774

 
 
 
 
 
 
 
 
 
 
 
 
 
As of December 31, 2016
 
Less Than 12 Months
 
More Than 12 Months
 
Total
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
AVAILABLE FOR SALE
 

 
 

 
 

 
 

 
 

 
 

Investment Securities:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
70,069

 
$
3,947

 
$
—

 
$
—

 
$
70,069

 
$
3,947

State and Political Subdivisions
264,485

 
12,069

 
887

 
1

 
265,372

 
12,070

   Other Equity Securities
5,920

 
119

 
—

 
—

 
5,920

 
119

Mortgage-backed Securities:
 
 
 
 
 
 
 
 
 
 
 
Residential
369,903

 
9,491

 
6,199

 
38

 
376,102

 
9,529

Commercial
245,422

 
3,055

 
—

 
—

 
245,422

 
3,055

Total
$
955,799

 
$
28,681

 
$
7,086

 
$
39

 
$
962,885

 
$
28,720

HELD TO MATURITY
 

 
 

 
 

 
 

 
 

 
 

Investment Securities:
 
 
 
 
 
 
 
 
 
 
 
State and Political Subdivisions
$
179,939

 
$
2,190

 
$
29,427

 
$
1,303

 
$
209,366

 
$
3,493

Mortgage-backed Securities:
 
 
 
 
 
 
 
 
 
 
 
Residential
107,024

 
950

 
—

 
—

 
107,024

 
950

Commercial
186,854

 
2,263

 
—

 
—

 
186,854

 
2,263

Total
$
473,817

 
$
5,403

 
$
29,427

 
$
1,303

 
$
503,244

 
$
6,706



14


We review those securities in an unrealized loss position for significant differences between fair value and the cost basis to evaluate if a classification of other-than-temporary impairment is warranted. In estimating other-than-temporary impairment losses, management considers, among other things, the length of time and the extent to which the fair value has been less than cost and the financial condition and near-term prospects of the issuer. We consider an other-than-temporary impairment to have occurred when there is an adverse change in expected cash flows. When it is determined that a decline in fair value of HTM or AFS securities is other-than-temporary, the carrying value of the security is reduced to its estimated fair value, with a corresponding charge to earnings for the credit portion and the noncredit portion to other comprehensive income. Based upon the length of time and the extent to which fair value is less than cost, we believe that none of the securities with an unrealized loss have other-than-temporary impairment at March 31, 2017 .
The majority of the securities in an unrealized loss position are highly rated municipal securities and U.S. Agency mortgage-backed securities (“MBS”) where the unrealized loss is a direct result of the change in interest rates and spreads. For those securities in an unrealized loss position, we do not currently intend to sell the securities and it is not more likely than not that we will be required to sell the securities before the anticipated recovery of their amortized cost basis. To the best of management’s knowledge and based on our consideration of the qualitative factors associated with each security, there were no securities in our investment and MBS portfolio with an other-than-temporary impairment at March 31, 2017 .
Our equity securities consist of investments that are deemed to be qualified under the Community Reinvestment Act (CRA) of 1977 and invest primarily in securities issued by Fannie Mae, Freddie Mac, and Ginnie Mae. We evaluated the near-term prospects of our other equity securities in relation to the severity and duration of the current unrealized loss position. Based upon that evaluation, management does not consider the other equity securities to be other-than-temporarily impaired at March 31, 2017 .

Interest income recognized on securities for the periods presented (in thousands):
 
 
 
 
 
Three Months Ended
March 31,
 
2017
 
2016
U.S. Treasury
$
315

 
$
127

State and Political Subdivisions
6,554

 
5,355

Other Stocks and Bonds
34

 
58

Other Equity Securities
28

 
29

Mortgage-backed Securities
10,045

 
9,391

Total interest income on securities
$
16,976

 
$
14,960


Of the approximately $322,000 in net securities gains from the AFS portfolio for the three months ended March 31, 2017 , there were $1.7 million in realized gain positions and $1.4 million in realized loss positions.  Of the $2.4 million in net securities gains from the AFS portfolio for the three months ended March 31, 2016 , there were $2.6 million in realized gain positions and $202,000 in realized loss positions. There were no sales from the HTM portfolio during the three months ended March 31, 2017 or 2016 . We calculate realized gains and losses on sales of securities under the specific identification method.  

15


The amortized cost, carrying value and estimated fair value of securities at March 31, 2017 , are presented below by contractual maturity (in thousands).  Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.  MBS are presented in total by category due to the fact that MBS typically are issued with stated principal amounts, and the securities are backed by pools of mortgages that have loans with varying maturities.  The characteristics of the underlying pool of mortgages, such as fixed-rate or adjustable-rate, as well as prepayment risk, are passed on to the security holder.  The term of a mortgage-backed pass-through security thus approximates the term of the underlying mortgages and can vary significantly due to prepayments.
 
March 31, 2017
 
Amortized Cost
 
Fair Value
AVAILABLE FOR SALE
 
Investment Securities:
 
 
 
Due in one year or less
$
6,694

 
$
6,851

Due after one year through five years
23,638

 
24,655

Due after five years through ten years
96,416

 
93,961

Due after ten years
270,236

 
261,252

 
396,984

 
386,719

Mortgage-backed Securities and Other Equity Securities:
1,060,300

 
1,057,324

Total
$
1,457,284

 
$
1,444,043


 
March 31, 2017
 
Carrying Value
 
Fair Value
HELD TO MATURITY
 
Investment Securities:
 
 
 
Due in one year or less
$
10,119

 
$
10,181

Due after one year through five years
39,539

 
39,935

Due after five years through ten years
101,274

 
101,898

Due after ten years
270,201

 
275,274

 
421,133

 
427,288

Mortgage-backed Securities:
508,660

 
513,121

Total
$
929,793

 
$
940,409


Investment securities and MBS with carrying values of $1.29 billion and $1.50 billion were pledged as of March 31, 2017 and December 31, 2016 , respectively, to collateralize Federal Home Loan Bank of Dallas (“FHLB”) advances, repurchase agreements, and public funds or for other purposes as required by law.

Securities with limited marketability, such as FHLB stock and other investments, are carried at cost, which approximates fair value and are assessed for other-than-temporary impairment.  These securities have no maturity date.

16



5.      Loans and Allowance for Probable Loan Losses

Loans in the accompanying consolidated balance sheets are classified as follows (in thousands):
    
 
March 31, 2017
 
December 31, 2016
Real Estate Loans:
 
 
 
Construction
$
362,367

 
$
380,175

1-4 Family Residential
622,881

 
637,239

Commercial
974,307

 
945,978

Commercial Loans
176,908

 
177,265

Municipal Loans
297,417

 
298,583

Loans to Individuals
105,038

 
117,297

Total Loans  (1)
2,538,918

 
2,556,537

Less: Allowance for Loan Losses (2)
18,485

 
17,911

Net Loans
$
2,520,433

 
$
2,538,626


(1)
Includes approximately $324.9 million and $372.4 million of loans acquired with the Omni acquisition as of March 31, 2017 and December 31, 2016 , respectively.
(2)
The allowance for loan loss recorded on purchase credit impaired (“PCI”) loans totaled $3,000 as of March 31, 2017 and December 31, 2016 .
Real Estate Construction Loans
Our construction loans are collateralized by property located primarily in or near the market areas we serve. Several of our construction loans will be owner occupied upon completion. Construction loans for non-owner occupied projects are financed, but these typically have cash flows from leases with tenants, secondary sources of repayment, and in some cases, additional collateral. Our construction loans have both adjustable and fixed interest rates during the construction period. Construction loans to individuals are typically priced and made with the intention of granting the permanent loan on the property. Speculative and commercial construction loans are subject to underwriting standards similar to that of the commercial portfolio.  Owner occupied 1-4 family residential construction loans are subject to the underwriting standards of the permanent loan.
Real Estate 1-4 Family Residential Loans
Residential loan originations are generated by our loan officers, in-house origination staff, marketing efforts, present customers, walk-in customers and referrals from real estate agents and builders.  We focus our lending efforts primarily on the origination of loans secured by first mortgages on owner occupied 1-4 family residences.  Substantially all of our 1-4 family residential originations are secured by properties located in or near our market areas.  
Our 1-4 family residential loans generally have maturities ranging from five to 30 years.  These loans are typically fully amortizing with monthly payments sufficient to repay the total amount of the loan.  Our 1-4 family residential loans are made at both fixed and adjustable interest rates.
Underwriting for 1-4 family residential loans includes debt-to-income analysis, credit history analysis, appraised value and down payment considerations. Changes in the market value of real estate can affect the potential losses in the portfolio.
Commercial Real Estate Loans
Commercial real estate loans as of March 31, 2017 consist of $902.9 million of owner and non-owner occupied real estate, $67.7 million of loans secured by multi-family properties and $3.7 million of loans secured by farmland. Commercial real estate loans primarily include loans collateralized by retail, commercial office buildings, multi-family, medical facilities and offices, senior living, assisted living and skilled nursing facilities, warehouse facilities, hotels and churches. In determining whether to originate commercial real estate loans, we generally consider such factors as the financial condition of the borrower and the debt service coverage of the property. Commercial real estate loans are made at both fixed and adjustable interest rates for terms generally up to 20 years.

17


Commercial Loans
Our commercial loans are diversified loan types including short-term working capital loans for inventory and accounts receivable and short- and medium-term loans for equipment or other business capital expansion.  Management does not consider there to be a concentration of risk in any one industry type. In our commercial loan underwriting, we assess the creditworthiness, ability to repay, and the value and liquidity of the collateral being offered.  Terms of commercial loans are generally commensurate with the useful life of the collateral offered.
Municipal Loans
We have a specific lending department that makes loans to municipalities and school districts primarily throughout the state of Texas.  Municipal loans outside the state of Texas have been limited to adjoining states. The majority of the loans to municipalities and school districts have tax or revenue pledges and in some cases are additionally supported by collateral.  Municipal loans made without a direct pledge of taxes or revenues are usually made based on some type of collateral that represents an essential service. 
Loans to Individuals
Substantially all originations of our loans to individuals are made to consumers in our market areas.  The majority of loans to individuals are collateralized by titled equipment, which are primarily automobiles. Loan terms vary according to the type and value of collateral, length of contract and creditworthiness of the borrower.  The underwriting standards we employ for consumer loans include an application, a determination of the applicant’s payment history on other debts, with the greatest weight being given to payment history with us, and an assessment of the borrower’s ability to meet existing obligations and payments on the proposed loan.  Although creditworthiness of the applicant is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, in relation to the proposed loan amount. Most of our loans to individuals are collateralized, which management believes should assist in limiting our exposure.
Allowance for Loan Losses
The allowance for loan losses is based on the most current review of the loan portfolio and is a result of multiple processes.  First, we utilize historical net charge-off data to establish general reserve amounts for each class of loans. The historical charge-off figure is further adjusted through qualitative factors that include general trends in past dues, nonaccruals and classified loans to more effectively and promptly react to both positive and negative movements not reflected in the historical data. Second, our lenders have the primary responsibility for identifying problem loans based on customer financial stress and underlying collateral.  These recommendations are reviewed by senior loan administration, the special assets department, and the loan review department on a monthly basis.  Third, the loan review department independently reviews the portfolio on an annual basis.  The loan review department follows a board-approved annual loan review scope.  The loan review scope encompasses a number of considerations including the size of the loan, the type of credit extended, the seasoning of the loan and the performance of the loan.  The loan review scope, as it relates to size, focuses more on larger dollar loan relationships, typically aggregate debt of $500,000 or greater.  The loan review officer also reviews specific reserves compared to general reserves to determine trends in comparative reserves as well as losses not reserved for prior to charge-off to determine the effectiveness of the specific reserve process.
At each review, a subjective analysis methodology is used to grade the respective loan.  Categories of grading vary in severity from loans that do not appear to have a significant probability of loss at the time of review to loans that indicate a probability that the entire balance of the loan will be uncollectible.  If at the time of review we determine it is probable that we will not collect the principal and interest cash flows contractually due on the loan, estimates of future expected cash flows or appraisals of the collateral securing the debt are used to determine the necessary allowances.  The internal loan review department maintains a list of all loans or loan relationships that are graded as having more than the normal degree of risk associated with them. In addition, a list of specifically reserved loans or loan relationships of $150,000 or more is updated on a quarterly basis in order to properly determine necessary allowances and keep management informed on the status of attempts to correct the deficiencies noted with respect to the loan.
We calculate historical loss ratios for pools of loans with similar characteristics based on the proportion of actual charge-offs experienced, consistent with the characteristics of remaining loans, to the total population of loans in the pool. The historical gross loss ratios are updated based on actual charge-off experience quarterly and adjusted for qualitative factors. All loans are subject to individual analysis if determined to be impaired with the exception of consumer loans and loans secured by 1-4 family residential loans.
Industry and our own experience indicates that a portion of our loans will become delinquent and a portion of the loans will require partial or full charge-off.  Regardless of the underwriting criteria utilized, losses may occur as a result of various factors beyond our control, including, among other things, changes in market conditions affecting the value of properties used as collateral for loans and problems affecting the credit worthiness of the borrower and the ability of the borrower to make payments on the

18


loan.  Our determination of the appropriateness of the allowance for loan losses is based on various considerations, including an analysis of the risk characteristics of various classifications of loans, previous loan loss experience, specific loans which would have loan loss potential, delinquency trends, estimated fair value of the underlying collateral, current economic conditions, and geographic and industry loan concentration.
Credit Quality Indicators
We categorize loans into risk categories on an ongoing basis based on relevant information about the ability of borrowers to service their debt such as:  current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors.  We use the following definitions for risk ratings:
•
Pass (Rating 1 – 4) – This rating is assigned to all satisfactory loans.  This category, by definition, consists of acceptable credit.  Credit and collateral exceptions should not be present, although their presence would not necessarily prohibit a loan from being rated Pass, if deficiencies are in process of correction.  These loans are not included in the Watch List.
•
Pass Watch (Rating 5) – These loans require some degree of special treatment, but not due to credit quality.  This category does not include loans specially mentioned or adversely classified; however, particular attention is warranted to characteristics such as:
◦
A lack of, or abnormally extended payment program;
◦
A heavy degree of concentration of collateral without sufficient margin;
◦
A vulnerability to competition through lesser or extensive financial leverage; and
◦
A dependence on a single or few customers or sources of supply and materials without suitable substitutes or alternatives.
•
Special Mention (Rating 6) – A Special Mention asset has potential weaknesses that deserve management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in our credit position at some future date.  Special Mention assets are not adversely classified and do not expose us to sufficient risk to warrant adverse classification.
•
Substandard (Rating 7) – Substandard loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any.  Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
•
Doubtful (Rating 8) – Loans classified as Doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation, in full, on the basis of currently known facts, conditions and values, highly questionable and improbable.
All accruing loans are reserved for as a group of similar type credits and included in the general portion of the allowance for loan losses. Loans to individuals and 1-4 family residential loans, including loans not accruing, are collectively evaluated and included in the general portion of the allowance for loan losses. All loans considered troubled debt restructurings (“TDR”) are evaluated individually for further impairment.
The general portion of the loan loss allowance is reflective of historical charge-off levels for similar loans adjusted for changes in current conditions and other relevant factors.  These factors are likely to cause estimated losses to differ from historical loss experience and include:
•
Changes in lending policies or procedures, including underwriting, collection, charge-off, and recovery procedures;
•
Changes in local, regional and national economic and business conditions, including entry into new markets;
•
Changes in the volume or type of credit extended;
•
Changes in the experience, ability, and depth of lending management;
•
Changes in the volume and severity of past due, nonaccrual, restructured, or classified loans;
•
Changes in charge-off trends;
•
Changes in loan review or Board oversight;
•
Changes in the level of concentrations of credit; and
•
Changes in external factors, such as competition and legal and regulatory requirements.

19


These factors are also considered for the purchased Omni loan portfolio specifically in regards to changes in credit quality, past due, nonaccrual and charge-off trends.
The following tables detail activity in the allowance for loan losses by portfolio segment for the periods presented (in thousands):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2017
 
Real Estate
 
 
 
 
 
 
 
 
 
Construction
 
1-4 Family
Residential
 
Commercial
 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 
Total
Balance at beginning of period  
$
4,147

 
$
2,665

 
$
7,204

 
$
2,263

 
$
750

 
$
882

 
$
17,911

Provision (reversal) for loan losses (1)
(722
)
 
(62
)
 
1,577

 
(112
)
 
(4
)
 
421

 
1,098

Loans charged off
(18
)
 
(287
)
 
—

 
(3
)
 
—

 
(746
)
 
(1,054
)
Recoveries of loans charged off
—

 
1

 
6

 
111

 
—

 
412

 
530

Balance at end of period
$
3,407

 
$
2,317

 
$
8,787

 
$
2,259

 
$
746

 
$
969

 
$
18,485



 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2016
 
Real Estate
 
 
 
 
 
 
 
 
 
Construction
 
1-4 Family
Residential
 
Commercial
 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 
Total
Balance at beginning of period
$
4,350

 
$
2,595

 
$
4,577

 
$
6,596

 
$
725

 
$
893

 
$
19,736

Provision (reversal) for loan losses  (1)
(42
)
 
(551
)
 
(116
)
 
2,620

 
(5
)
 
410

 
2,316

Loans charged off
—

 
(19
)
 
—

 
(273
)
 
—

 
(848
)
 
(1,140
)
Recoveries of loans charged off
269

 
130

 
6

 
21

 
—

 
461

 
887

Balance at end of period
$
4,577

 
$
2,155

 
$
4,467

 
$
8,964

 
$
720

 
$
916

 
$
21,799

(1)
Of the $1.1 million and $2.3 million recorded in provision for loan losses for the three months ended March 31, 2017 and March 31, 2016 , none related to provision expense on PCI loans as of March 31, 2017 and $296,000 related to provision expense on PCI loans as of March 31, 2016 .
The following tables present the balance in the allowance for loan losses by portfolio segment based on impairment method (in thousands):
 
As of March 31, 2017
 
Real Estate
 
 
 
 
 
 
 
 
 
Construction
 
1-4 Family
Residential
 
Commercial
 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 
Total
Ending balance – individually evaluated for impairment (1)
$
10

 
$
13

 
$
15

 
$
982

 
$
11

 
$
91

 
$
1,122

Ending balance – collectively evaluated for impairment
3,397

 
2,304

 
8,772

 
1,277

 
735

 
878

 
17,363

Balance at end of period
$
3,407

 
$
2,317

 
$
8,787

 
$
2,259

 
$
746

 
$
969

 
$
18,485



20


 
As of December 31, 2016
 
Real Estate
 
 
 
 
 
 
 
 
 
Construction
 
1-4 Family
Residential
 
Commercial
 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 
Total
Ending balance – individually evaluated for impairment (1)
$
13

 
$
16

 
$
17

 
$
923

 
$
11

 
$
106

 
$
1,086

Ending balance – collectively evaluated for impairment
4,134

 
2,649

 
7,187

 
1,340

 
739

 
776

 
16,825

Balance at end of period
$
4,147

 
$
2,665

 
$
7,204

 
$
2,263

 
$
750

 
$
882

 
$
17,911


(1)
There was approximately $3,000 of allowance for loan losses associated with PCI loans as of March 31, 2017 and December 31, 2016 .

The following tables present the recorded investment in loans by portfolio segment based on impairment method (in thousands):
 
March 31, 2017
 
Real Estate
 
 
 
 
 
 
 
 
 
Construction
 
1-4 Family
Residential
 
Commercial
 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 
Total
Loans individually evaluated for impairment
$
430

 
$
1,672

 
$
1,081

 
$
5,529

 
$
571

 
$
225

 
$
9,508

Loans collectively evaluated for impairment
361,784

 
615,628

 
971,593

 
170,090

 
296,846

 
104,712

 
2,520,653

Purchased credit impaired loans
153

 
5,581

 
1,633

 
1,289

 
—

 
101

 
8,757

Total ending loan balance
$
362,367

 
$
622,881

 
$
974,307

 
$
176,908

 
$
297,417

 
$
105,038

 
$
2,538,918


 
December 31, 2016
 
Real Estate
 
 
 
 
 
 
 
 
 
Construction
 
1-4 Family
Residential
 
Commercial
 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 
Total
Loans individually evaluated for impairment
$
480

 
$
1,693

 
$
1,184

 
$
5,840

 
$
571

 
$
241

 
$
10,009

Loans collectively evaluated for impairment
379,526

 
629,893

 
942,818

 
170,159

 
298,012

 
116,923

 
2,537,331

Purchased credit impaired loans
169

 
5,653

 
1,976

 
1,266

 
—

 
133

 
9,197

Total ending loan balance
$
380,175

 
$
637,239

 
$
945,978

 
$
177,265

 
$
298,583

 
$
117,297

 
$
2,556,537




21


The following tables set forth credit quality indicators by class of loans for the periods presented (in thousands):
 
March 31, 2017
 
Pass
 
Pass Watch (1)
 
Special Mention (1)
 
Substandard (1)
 
Doubtful (1)
 
Total
Real Estate Loans:
 
 
 
 
 
 
 
 
 
 
 
Construction
$
358,837

 
$
33

 
$
159

 
$
3,320

 
$
18

 
$
362,367

1-4 Family Residential
618,810

 
14

 
—

 
3,626

 
431

 
622,881

Commercial
922,584

 
3,258

 
8,657

 
39,808

 
—

 
974,307

Commercial Loans
162,780

 
1,167

 
4,372

 
8,544

 
45

 
176,908

Municipal Loans
295,896

 
—

 
950

 
571

 
—

 
297,417

Loans to Individuals
103,874

 
—

 
27

 
650

 
487

 
105,038

Total
$
2,462,781

 
$
4,472

 
$
14,165

 
$
56,519

 
$
981

 
$
2,538,918


 
December 31, 2016
 
Pass
 
Pass Watch (1)
 
Special Mention (1)
 
Substandard  (1)
 
Doubtful (1)
 
Total
Real Estate Loans:
 
 
 
 
 
 
 
 
 
 
 
Construction
$
374,443

 
$
34

 
$
571

 
$
5,108

 
$
19

 
$
380,175

1-4 Family Residential
632,937

 
68

 
—

 
3,380

 
854

 
637,239

Commercial
885,049

 
17,739

 
10,587

 
32,603

 
—

 
945,978

Commercial Loans
158,943

 
1,187

 
8,086

 
9,012

 
37

 
177,265

Municipal Loans
297,014

 
—

 
998

 
571

 
—

 
298,583

Loans to Individuals
115,952

 
—

 
9

 
629

 
707

 
117,297

Total
$
2,464,338

 
$
19,028

 
$
20,251

 
$
51,303

 
$
1,617

 
$
2,556,537


(1)
Includes PCI loans comprised of $5,000 pass watch, $507,000 special mention, $1.1 million substandard and $28,000 doubtful as of March 31, 2017 . Includes PCI loans comprised of $5,000 pass watch, $511,000 special mention, $1.5 million substandard and $28,000 doubtful as of December 31, 2016 .

Nonperforming Assets and Past Due Loans

Nonaccrual loans are loans 90 days or more delinquent and collection in full of both the principal and interest is not expected.  Additionally, some loans that are not delinquent may be placed on nonaccrual status due to doubts about full collection of principal or interest.  When a loan is categorized as nonaccrual, the accrual of interest is discontinued and any accrued balance is reversed for financial statement purposes.  Payments received on nonaccrual loans are applied to the outstanding principal balance. Payments of contractual interest are recognized as income only to the extent that full recovery of the principal balance of the loan is reasonably certain.  Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.  Other factors, such as the value of collateral securing the loan and the financial condition of the borrower, are considered in judgments as to potential loan loss.

Nonaccrual loans and accruing loans past due more than 90 days include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

PCI loans are recorded at fair value at acquisition date. Although the PCI loans may be contractually delinquent, we do not classify these loans as past due or nonperforming as the loans were written down to fair value at the acquisition date and the accretable yield is recognized in interest income over the remaining life of the loan. However, subsequent to acquisition, we re-assess PCI loans for additional impairment and record additional impairment in the event we conclude it is probable that we will be unable to collect all cash flows originally expected to be collected at acquisition plus any additional cash flows expected to be collected due to changes in estimates after acquisition. All such PCI loans for which we recognize subsequent impairment are reported as impaired loans in the financial statements.




22


The following table sets forth nonperforming assets for the periods presented (in thousands):

 
At
March 31,
2017
 
At
December 31,
2016
Nonaccrual loans  (1)
$
7,261

 
$
8,280

Accruing loans past due more than 90 days (1)
1

 
6

Restructured loans (2)
6,424

 
6,431

Other real estate owned
367

 
339

Repossessed assets
26

 
49

Total Nonperforming Assets
$
14,079

 
$
15,105


(1)
Excludes PCI loans measured at fair value at acquisition.
(2)
Includes $3.0 million and $3.1 million in PCI loans restructured as of March 31, 2017 and December 31, 2016 , respectively.

Foreclosed assets include other real estate owned and repossessed assets. For 1-4 family residential real estate properties, a loan is recognized as a foreclosed property once legal title to the real estate property has been received upon completion of foreclosure or the borrower has conveyed all interest in the residential property through a deed in lieu of foreclosure. As of March 31, 2017 , there were no loans secured by 1-4 family residential properties for which formal foreclosure proceedings were in process. As of December 31, 2016 , there were $28,000 in loans secured by 1-4 family residential properties for which formal foreclosure proceedings were in process.

The following table sets forth the recorded investment in nonaccrual loans by class of loans for the periods presented (in thousands). The table ex cludes PCI loans measured at fair value at acquisition :

 
Nonaccrual Loans
 
March 31, 2017
 
December 31, 2016
Real Estate Loans:
 
 
 
Construction
$
55

 
$
105

1-4 Family Residential
673

 
1,067

Commercial
723

 
808

Commercial Loans
5,127

 
5,477

Loans to Individuals
683

 
823

Total
$
7,261

 
$
8,280


Loans are considered impaired if, based on current information and events, it is probable we will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement.  Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. The measurement of loss on impaired loans is generally based on the fair value of the collateral less selling costs if repayment is expected solely from the collateral or the present value of the expected future cash flows discounted at the historical effective interest rate stipulated in the loan agreement. In measuring the fair value of the collateral, in addition to relying on third party appraisals, we use assumptions, such as discount rates, and methodologies, such as comparison to the recent selling price of similar assets, consistent with those that would be utilized by unrelated third parties performing a valuation. Loans that are evaluated and determined not to meet the definition of an impaired loan are reserved for at the general reserve rate for its appropriate class.

At the time a loss is probable in the collection of contractual amounts, specific reserves are allocated.  Loans are charged off to the liquidation value of the collateral net of liquidation costs, if any, when deemed uncollectible or as soon as collection by liquidation is evident.




23


The following tables set forth impaired loans by class of loans for the periods presented (in thousands). Impaired loans include restructured and nonaccrual loans for which the allowance was measured in accordance with section 310-10 of ASC Topic 310, “Receivables.” There were no impaired loans recorded without an allowance as of March 31, 2017 or December 31, 2016 .
 
March 31, 2017
 
Unpaid Contractual Principal Balance
 
Recorded Investment
 
Related
 Allowance for
 Loan Losses
Real Estate Loans:
 
 
 
 
 
Construction
$
437

 
$
430

 
$
10

1-4 Family Residential
4,429

 
4,221

 
13

Commercial
1,530

 
1,465

 
15

Commercial Loans
5,798

 
5,638

 
982

Municipal Loans
571

 
571

 
11

Loans to Individuals
256

 
225

 
91

Total (1)
$
13,021

 
$
12,550

 
$
1,122


 
December 31, 2016
 
Unpaid
Contractual
Principal
Balance
 
Recorded
Investment
 
Related
 Allowance for
 Loan Losses
Real Estate Loans:
 
 
 
 
 
Construction
$
486

 
$
480

 
$
13

1-4 Family Residential
4,487

 
4,264

 
16

Commercial
1,631

 
1,574

 
17

Commercial Loans
6,108

 
5,941

 
923

Municipal Loans
571

 
571

 
11

Loans to Individuals
277

 
241

 
106

Total (1)
$
13,560

 
$
13,071

 
$
1,086


(1)
Includes $3.0 million and $3.1 million of PCI loans that experienced deterioration in credit quality subsequent to the acquisition date as of March 31, 2017 and December 31, 2016 , respectively.




24


The following tables present the aging of the recorded investment in past due loans by class of loans (in thousands):

 
March 31, 2017
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 
Greater than 90 Days Past Due
 
Total Past
Due
 
Current (1)
 
Total
Real Estate Loans:
 
 
 
 
 
 
 
 
 
 
 
Construction
$
2,423

 
$
—

 
$
22

 
$
2,445

 
$
359,922

 
$
362,367

1-4 Family Residential
5,330

 
81

 
329

 
5,740

 
617,141

 
622,881

Commercial
1,179

 
151

 
81

 
1,411

 
972,896

 
974,307

Commercial Loans
2,020

 
686

 
2,707

 
5,413

 
171,495

 
176,908

Municipal Loans
663

 
—

 
—

 
663

 
296,754

 
297,417

Loans to Individuals
850

 
108

 
267

 
1,225

 
103,813

 
105,038

Total
$
12,465

 
$
1,026

 
$
3,406

 
$
16,897

 
$
2,522,021

 
$
2,538,918


 
December 31, 2016
 
30-59 Days Past Due
 
60-89 Days Past Due
 
Greater than 90 Days
Past Due
 
Total Past
Due
 
Current (1)
 
Total
Real Estate Loans:
 
 
 
 
 
 
 
 
 
 
 
Construction
$
917

 
$
64

 
$
86

 
$
1,067

 
$
379,108

 
$
380,175

1-4 Family Residential
6,225

 
755

 
600

 
7,580

 
629,659

 
637,239

Commercial
70

 
154

 
154

 
378

 
945,600

 
945,978

Commercial Loans
783

 
300

 
3,459

 
4,542

 
172,723

 
177,265

Municipal Loans
113

 
—

 
—

 
113

 
298,470

 
298,583

Loans to Individuals
1,550

 
320

 
185

 
2,055

 
115,242

 
117,297

Total
$
9,658

 
$
1,593

 
$
4,484

 
$
15,735

 
$
2,540,802

 
$
2,556,537


(1)    Includes PCI loans measured at fair value at acquisition.

The following table sets forth average recorded investment and interest income recognized on impaired loans by class of loans for the periods presented (in thousands). The table excludes PCI loans measured at fair value at acquisition that have not experienced further deterioration in credit quality subsequent to the acquisition date :
 
 
 
 
 
 
 
 
 
Three Months Ended
 
March 31, 2017
 
March 31, 2016
 
Average Recorded Investment
 
Interest Income Recognized
 
Average Recorded
Investment
 
Interest Income Recognized
Real Estate Loans:
 
 
 
 
 
 
 
Construction
$
467

 
$
4

 
$
454

 
$
6

1-4 Family Residential
4,262

 
57

 
1,865

 
14

Commercial
1,522

 
19

 
5,488

 
21

Commercial Loans
5,787

 
19

 
21,675

 
167

Municipal Loans
571

 
8

 
637

 
9

Loans to Individuals
265

 
2

 
247

 
2

Total
$
12,874

 
$
109

 
$
30,366

 
$
219




25


Troubled Debt Restructurings

The restructuring of a loan is considered a TDR if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession.  Concessions may include interest rate reductions or below market interest rates, restructuring amortization schedules and other actions intended to minimize potential losses. We may provide a combination of concessions which may include an extension of the amortization period, interest rate reduction, and/or converting the loan to interest-only for a limited period of time.

The following tables set forth the recorded balance of loans considered to be TDRs that were restructured and the type of concession during the periods presented (dollars in thousands):
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2017
 
Extend Amortization
 Period
 
Interest Rate Reductions
 
Combination
 
Total Modifications
 
Number of Loans
Commercial Loans
$
47

 
$
—

 
$
—

 
$
47

 
1

Loans to Individuals
5

 
—

 
12

 
17

 
2

Total
$
52

 
$
—

 
$
12

 
$
64

 
3

 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2016
 
Extend Amortization
 Period
 
Interest Rate Reductions
 
Combination
 
Total Modifications
 
Number of Loans
Real Estate Loans:
 
 
 
 
 
 
 
 
 
Construction
$
554

 
$
—

 
$
—

 
$
554

 
1

Commercial
2,118

 
—

 
—

 
2,118

 
1

Commercial Loans
1,176

 
—

 
—

 
1,176

 
4

Total
$
3,848

 
$
—

 
$
—

 
$
3,848

 
6


The majority of loans restructured as TDRs during the three months ended March 31, 2017 and 2016 were modified with maturity extensions. Interest continues to be charged on principal balances outstanding during the extended term. Therefore, the financial effects of the recorded investment of loans restructured as TDRs during the three months ended March 31, 2017 and 2016 were not significant. Generally, the loans identified as TDRs were previously reported as impaired loans prior to restructuring and therefore the modification did not impact our determination of the allowance for loan losses.
On an ongoing basis, the performance of the TDRs is monitored for subsequent payment default. Payment default for TDRs is recognized when the borrower is 90 days or more past due. For the three months ended March 31, 2017 , the amount of TDRs in default was not significant. For the three months ended March 31, 2016 , there were $1.4 million of TDRs in default. Payment defaults for TDRs did not significantly impact the determination of the allowance for loan loss in either period presented.
At March 31, 2017 and 2016 , there were no commitments to lend additional funds to borrowers whose terms had been modified in TDRs.


26


Purchased Credit Impaired Loans

The following table presents the outstanding principal balance and carrying value for PCI loans for the periods presented (in thousands):
 
March 31, 2017
 
December 31, 2016
Outstanding principal balance
$
9,924

 
$
10,612

Carrying amount
$
8,757

 
$
9,197


The following table presents the changes in the accretable yield during the periods for PCI loans (in thousands):
 
Three Months Ended
March 31,
 
2017
 
2016
Balance at beginning of period
$
2,480

 
$
2,493

Reclassifications (to) from nonaccretable discount
1,819

 
443

Accretion
(296
)
 
(594
)
Balance at end of period
$
4,003

 
$
2,342


6.      Long-term Obligations

Long-term obligations are summarized as follows (in thousands):
 
March 31,
2017
 
December 31,
2016
Parent Company
 
 
 
Subordinated notes: (1)
 
 
 
5.50% Subordinated Notes Due 2026, net of unamortized debt issuance costs (2)
$
98,133

 
$
98,100

Total Subordinated notes
98,133

 
98,100

Long-term debt: (3)
 
 
 
Southside Statutory Trust III Due 2033, net of unamortized debt issuance costs (4)
20,545

 
20,544

Southside Statutory Trust IV Due 2037 (5)
23,196

 
23,196

Southside Statutory Trust V Due 2037 (6)
12,887

 
12,887

Magnolia Trust Company I Due 2035 (7)
3,609

 
3,609

Total Long-term debt
60,237

 
60,236

Total Parent Company
158,370

 
158,336

 
 
 
 
Subsidiaries
 
 
 
FHLB advances (8)
252,940

 
443,128

Total Subsidiaries
252,940

 
443,128

Total Long-term obligations
$
411,310

 
$
601,464


(1)
This long-term debt consists of subordinated notes with a remaining maturity greater than one year that qualify under the risk-based capital guidelines as Tier 2 capital, subject to certain limitations.
(2)
This debt carries a fixed rate of 5.50% through September 29, 2021 and thereafter, adjusts quarterly at a rate equal to three-month LIBOR plus 429.7 basis points .
(3)
This long-term debt consists of trust preferred securities that qualify under the risk-based capital guidelines as Tier 1 capital, subject to certain limitations.
(4)
This debt carries an adjustable rate of 4.08678% through June 29, 2017 and adjusts quarterly at a rate equal to three-month LIBOR plus 294 basis points .
(5)
This debt carries an adjustable rate of 2.339% through April 29, 2017 and adjusts quarterly at a rate equal to three-month LIBOR plus 130 basis points .

27


(6)
This debt carries an adjustable rate of 3.38122% through June 14, 2017 and adjusts quarterly at a rate equal to three-month LIBOR plus 225 basis points .
(7)
This debt carries an adjustable rate of 2.85344% through May 22, 2017 and adjusts quarterly at a rate equal to three-month LIBOR plus 180 basis points .
(8)
At March 31, 2017 , the weighted average cost of these advances was 1.5% .  Long-term FHLB advances have maturities ranging from April 2018 through July 2028 .

On September 19, 2016 , the Company issued $100.0 million aggregate principal amount of fixed-to-floating rate subordinated notes that mature on September 30, 2026 . This debt initially bears interest at a fixed rate of 5.50% through September 29, 2021 and thereafter, adjusts quarterly at a floating rate equal to three-month LIBOR plus 429.7 basis points . The proceeds from the sale of the subordinated notes were used for general corporate purposes, which included advances to the Bank to finance its activities. The unamortized discount and debt issuance costs deducted from the subordinated notes issued totaled approximately $1.9 million at both March 31, 2017 and December 31, 2016 .

The unamortized debt issuance costs reflected in the carrying amount of the Southside Statutory Trust III junior subordinated debentures totaled $74,000 at March 31, 2017 and $75,000 at December 31, 2016 .

During the last sixteen months, the Company entered into various variable rate advances with the FHLB . These advances totaled $240.0 million at March 31, 2017 and $250.0 million at December 31, 2016 , of which $60.0 million and $230.0 million were considered long-term at March 31, 2017 and December 31, 2016 , respectively. Two of the variable rate advances have interest rates of three-month LIBOR minus 25 basis points. The remaining advances have interest rates ranging from one-month LIBOR plus 0.17% to one-month LIBOR plus 0.278% . In connection with obtaining these advances, the Company entered into various interest rate swap contracts that are treated as cash flow hedges under ASC Topic 815, “Derivatives and Hedging” that effectively converted the variable rate advances to fixed interest rates ranging from 0.932% to 2.345% and original terms ranging from five years to ten years. The cash flows from the swaps are expected to be effective in hedging the variability in future cash flows attributable to fluctuations in the one-month and three-month LIBOR interest rates. During the first quarter of 2017 , we terminated two interest rate swap contracts designated as cash flow hedges having a total notional value of $40.0 million . At the time of termination, we determined that the underlying hedged forecasted transactions were still probable of occurring. Refer to “Note 8 - Derivative Financial Instruments and Hedging Activities” in our consolidated financial statements included in this report for a detailed description of our hedging policy and methodology related to derivative instruments.

7.      Employee Benefit Plans

The components of net periodic benefit cost (income) are as follows (in thousands):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31,
 
 
Defined Benefit
Pension Plan
 
Defined Benefit Pension Plan Acquired
 
Restoration
Plan
 
 
2017
 
2016
 
2017
 
2016
 
2017
 
2016
Service cost
 
$
358

 
$
368

 
$
—

 
$
—

 
$
51

 
$
47

Interest cost
 
912

 
917

 
45

 
53

 
132

 
135

Expected return on assets
 
(1,512
)
 
(1,354
)
 
(54
)
 
(67
)
 
—

 
—

Net loss amortization
 
344

 
358

 
—

 
—

 
47

 
53

Prior service (credit) cost amortization
 
(4
)
 
(6
)
 
—

 
—

 
2

 
2

Special and contractual termination benefits
 
—

 
1,520

 
—

 
—

 
—

 
—

Net periodic benefit cost (income)
 
$
98

 
$
1,803

 
$
(9
)
 
$
(14
)
 
$
232

 
$
237


8.     Derivative Financial Instruments and Hedging Activities

Our hedging policy allows the use of interest rate derivative instruments to manage our exposure to interest rate risk or hedge specified assets and liabilities. These instruments may include interest rate swaps and interest rate caps and floors. All derivative instruments are carried on the balance sheet at their estimated fair value and are recorded in other assets or other liabilities, as appropriate.

Derivative instruments may be designated as cash flow hedges of variable rate assets or liabilities, or as cash flow hedges of forecasted transactions. Derivative instruments designated as cash flow hedges are recorded in accumulated other comprehensive income to the extent that they are effective. The amount recorded in other comprehensive income is reclassified to earnings in the same periods that the hedged cash flows impact earnings. The ineffective portion of changes in fair value is reported in current earnings.

From time to time, we enter into certain interest rate swap contracts on specific variable-rate advance agreements with the FHLB. These interest rate swap contracts were designated as hedging instruments in cash flow hedges under ASC Topic 815. The objective of the interest rate swap contracts is to manage the expected future cash flows on $240.0 million of variable-rate advance agreements with the FHLB. The cash flows from the swap are expected to be effective in hedging the variability in future cash flows attributable to fluctuations in the underlying LIBOR interest rate.

In accordance with ASC Topic 815, if a hedging item is terminated prior to maturity for a cash settlement, the existing gain or loss within accumulated other comprehensive income will continue to be reclassified into earnings during the period or periods in which the hedged forecasted transaction affects earnings unless it is probable that the forecasted transaction will not occur by the end of the originally specified time period. If the forecasted transaction is deemed probable to not occur, the derivative gain or loss reported in accumulated other comprehensive income shall be reclassified into earnings immediately. During the first quarter of 2017, we terminated two interest rate swap contracts designated as cash flow hedges. At the time of termination, we determined that the underlying hedged forecasted transactions were still probable of occurring. The existing gain in accumulated other comprehensive income will be reclassified into earnings through straight-line accretion in the same periods the hedged forecasted transaction affects earnings.
At March 31, 2017 , net derivative assets included $7.4 million of cash collateral received from counterparties under master netting agreements and net derivative liabilities included $408,000 of cash collateral held by a counterparty to a master netting agreement. At March 31, 2017 , we had $42,000 of cash collateral receivable that was not offset against derivative liabilities.
From time to time, we may enter into certain interest rate swaps, cap, and floor contracts that are not designated as hedging instruments. These interest rate derivative contracts relate to transactions in which we enter into an interest rate swap, cap, or floor with a customer while concurrently entering into an offsetting interest rate swap, cap, or floor with a third-party financial institution. We agree to pay interest to the customer on a notional amount at a variable rate and receive interest from the customer on a similar notional amount at a fixed interest rate. At the same time, we agree to pay a third-party financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. These interest rate derivative contracts allow our customers to effectively convert a variable rate loan to a fixed rate loan. The changes in the fair value of the underlying derivative contracts primarily offset each other and do not significantly impact our results of operations. For derivative instruments not designated as hedging instruments, the gain or loss is recognized in current earnings during the period of change. We recognized swap fee income associated with these derivative contracts immediately based upon the difference in the bid/ask spread of the underlying transactions with the customer and the third-party financial institution. The swap fee income is included in other noninterest income in our consolidated statements of income.

The notional amounts of the derivative instruments represent the contractual cash flows pertaining to the underlying agreements. These amounts are not exchanged and are not reflected in the consolidated balance sheets. The fair value of the interest rate swaps are presented at net in other assets and other liabilities when a right of offset exists, based on transactions with a single counterparty that are subject to a legally enforceable master netting agreement.

28


The following tables present the notional and estimated fair value amount of derivative positions outstanding for the periods presented (in thousands):
 
 
March 31, 2017
 
December 31, 2016
 
 
Estimated Fair Value
 
Estimated Fair Value
 
 
Notional
Amount (1)
 
Asset Derivative
 
Liability Derivative
 
Notional
Amount (1)
 
Asset Derivative
 
Liability Derivative
Derivatives designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
Interest rate contracts:
 
 
 
 
 
 
 
 
 
 
 
 
Swaps-Cash Flow Hedge-Financial institution counterparties
 
$
240,000

 
$
7,404

 
$
36

 
$
250,000

 
$
7,069

 
$
—

Derivatives designated as non-hedging instruments
 
 
 
 
 
 
 
 
Interest rate contracts:
 
 
 
 
 
 
 
 
 
 
 
 
Swaps-Financial institution counterparties
 
46,196

 
91

 
499

 
2,182

 
85

 
—

Swaps-Customer counterparties
 
46,196

 
499

 
91

 
2,182

 
—

 
85

Gross derivatives
 
 
 
7,994

 
626

 

 
7,154

 
85

Offsetting derivative assets/liabilities
 
 
 
(127
)
 
(127
)
 
 
 
—

 
—

Cash collateral received/posted
 
 
 
(7,360
)
 
(408
)
 
 
 
(7,154
)
 
—

Net derivatives included in the consolidated balance sheets (2)
 
 
 
$
507

 
$
91

 

 
$
—

 
$
85

(1)
Notional amounts, which represent the extent of involvement in the derivatives market, are used to determine the contractual cash flows required in accordance with the terms of the agreement. These amounts are typically not exchanged, significantly exceed amounts subject to credit or market risk, and are not reflected in the consolidated balance sheets.
(2)
Net derivative assets are included in “other assets” and net derivative liabilities are included in “other liabilities” on the consolidated balance sheets. Included in the fair value of net derivative assets and net derivative liabilities are credit valuation adjustments reflecting counterparty credit risk and our credit risk. We had net credit exposure of $8,000 related to interest rate swaps with financial institutions and $499,000 related to interest rate swaps with customers at March 31, 2017 . The credit risk associated with customer transactions is partially mitigated as these transactions are generally secured by the non-cash collateral securing the underlying transaction being hedged. We had no credit exposure related to interest rate swaps with financial or customer counterparties at December 31, 2016 .
The summarized expected weighted average remaining maturity of the notional amount of interest rate swaps and the weighted average interest rates associated with the amounts expected to be received or paid on interest rate swap agreements are presented below (dollars in thousands). Variable rates received on pay fixed swaps are based on one-month or three-month LIBOR rates in effect at March 31, 2017 and December 31, 2016 :

 
 
March 31, 2017
 
December 31, 2016
 
 
 
 
Weighted Average
 
 
 
Weighted Average
 
 
Notional Amount
 
Remaining Maturity
 (in years)
 
Receive Rate
 
Pay
Rate  
 
Notional Amount
 
Remaining Maturity
(in years)
 
Receive Rate
 
Pay
Rate
Swaps-Cash Flow Hedge
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial institution counterparties
 
$
240,000

 
6.0
 
0.91
%
 
1.43
%
 
$
250,000

 
5.4
 
0.68
%
 
1.31
%
Swaps-Non-Hedging
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial institution counterparties
 
46,196

 
10.3
 
0.83

 
2.32

 
2,182

 
9.7
 
0.62

 
1.57

Customer counterparties
 
46,196

 
10.3
 
2.32

 
0.83

 
2,182

 
9.7
 
1.57

 
0.62


9.  Fair Value Measurement
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.  A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability.  The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability is not adjusted for transaction costs.  An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction.  Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.
Valuation techniques including the market approach, the income approach and/or the cost approach are utilized to determine fair value.  Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability.  Valuation policies and procedures are determined by our investment department and reported to our Asset/Liability Committee (“ALCO”) for review.  An entity must consider all aspects of nonperforming risk, including the entity’s own credit standing, when measuring fair value of a liability.  Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.  A fair value hierarchy for valuation inputs gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.  The fair value hierarchy is as follows:
Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.  These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.
Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

Level 3 assets recorded at fair value on a nonrecurring basis at March 31, 2017 and December 31, 2016 , included loans for which a specific allowance was established based on the fair value of collateral and commercial real estate for which fair value of the properties was less than the cost basis.  For both asset classes, the unobservable inputs were the additional adjustments applied by management to the appraised values to reflect such factors as non-current appraisals and revisions to estimated time to sell.  These adjustments are determined based on qualitative judgments made by management on a case-by-case basis and are not quantifiable inputs, although they are used in the determination of fair value.

A description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

Certain financial assets are measured at fair value in accordance with GAAP.  Adjustments to the fair value of these assets usually result from the application of fair value accounting or write-downs of individual assets.  Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with our monthly and/or quarterly valuation process.  There were no transfers between Level 1 and Level 2 during the three months ended March 31, 2017 or the year ended December 31, 2016 .

Securities Available for Sale – U.S. Treasury securities and other equity securities are reported at fair value utilizing Level 1 inputs.  Other securities classified as available for sale are reported at fair value utilizing Level 2 inputs.  For these securities, we obtain fair value measurements from independent pricing services.  The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

We review the prices supplied by the independent pricing services for reasonableness and to ensure such prices are aligned with traditional pricing matrices.  In addition, we obtain an understanding of their underlying pricing methodologies and their Statement on Standards for Attestation Engagements-Reporting on Controls of a Service Organization (“SSAE 16”). We validate prices supplied by the independent pricing services by comparison to prices obtained from, in most cases, three additional third

29


party sources. For securities where prices are outside a reasonable range, we further review those securities to determine what a reasonable price estimate is for that security, given available data.

Derivatives – Derivatives are reported at fair value utilizing Level 2 inputs. We obtain fair value measurements from three sources including an independent pricing service and the counterparty to the derivatives designated as hedges.  The fair value measurements consider observable data that may include dealer quotes, market spreads, the U.S. Treasury yield curve, live trading levels, trade execution data, credit information and the derivatives’ terms and conditions, among other things. We review the prices supplied by the sources for reasonableness.  In addition, we obtain a basic understanding of their underlying pricing methodology.  We validate prices supplied by the sources by comparison to one another.

Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis, which means that the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). Financial assets and financial liabilities measured at fair value on a nonrecurring basis included foreclosed assets and impaired loans at March 31, 2017 and December 31, 2016 .

Foreclosed Assets – Foreclosed assets are initially recorded at fair value less costs to sell.  The fair value measurements of foreclosed assets can include Level 2 measurement inputs such as real estate appraisals and comparable real estate sales information, in conjunction with Level 3 measurement inputs such as cash flow projections, qualitative adjustments, and sales cost estimates.  As a result, the categorization of foreclosed assets is Level 3 of the fair value hierarchy.  In connection with the measurement and initial recognition of certain foreclosed assets, we may recognize charge-offs through the allowance for loan losses.

Impaired Loans – Certain impaired loans may be reported at the fair value of the underlying collateral if repayment is expected solely from the collateral.  Collateral values are estimated using Level 3 inputs based on customized discounting criteria or appraisals.  At March 31, 2017 and December 31, 2016 , the impact of loans with specific reserves based on the fair value of the collateral was reflected in our allowance for loan losses.

Certain nonfinancial assets and nonfinancial liabilities measured at fair value on a recurring basis include reporting units measured at fair value and tested for goodwill impairment. 

The following tables summarize assets measured at fair value on a recurring and nonrecurring basis segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (in thousands):

30


 
As of March 31, 2017
 
 
 
Fair Value Measurements at the End of the Reporting Period Using
 
Carrying
Amount
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
Recurring fair value measurements
 
 
 
 
 
 
 
Investment Securities:
 
 
 
 
 
 
 
U.S. Treasury
$
59,214

 
$
59,214

 
$
—

 
$
—

State and Political Subdivisions
320,847

 
—

 
320,847

 
—

Other Stocks and Bonds
6,658

 
—

 
6,658

 
—

  Other Equity Securities
5,920

 
5,920

 
—

 
—

Mortgage-backed Securities: (1)
 
 
 
 
 
 
 
Residential
684,662

 
—

 
684,662

 
—

Commercial
366,742

 
—

 
366,742

 
—

Derivative assets:
 
 
 
 
 
 
 
Interest rate swaps
7,994


—


7,994


—

Total asset recurring fair value measurements
$
1,452,037

 
$
65,134

 
$
1,386,903

 
$
—

 
 
 
 
 
 
 
 
Derivative liabilities:
 
 
 
 
 
 
 
Interest rate swaps
$
626


$
—


$
626


$
—

Total liability recurring fair value measurements
$
626

 
$
—

 
$
626

 
$
—

 
 
 
 
 
 
 
 
Nonrecurring fair value measurements
 

 
 

 
 

 
 

Foreclosed assets
$
393

 
$
—

 
$
—

 
$
393

Impaired loans (2)
9,137

 
—

 
—

 
9,137

Total asset nonrecurring fair value measurements
$
9,530

 
$
—

 
$
—

 
$
9,530


31


 
As of December 31, 2016
 
 
 
Fair Value Measurements at the End of the Reporting Period Using
 
Carrying
Amount
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
Recurring fair value measurements
 
 
 
 
 
 
 
Investment Securities:
 
 
 
 
 
 
 
U.S. Treasury
$
70,069

 
$
70,069

 
$
—

 
$
—

State and Political Subdivisions
385,197

 
—

 
385,197

 
—

Other Stocks and Bonds
6,651

 
—

 
6,651

 
—

  Other Equity Securities
5,920

 
5,920

 
—

 
—

Mortgage-backed Securities: (1)
 
 
 

 
 
 
 
Residential
627,508

 
—

 
627,508

 
—

Commercial
384,255

 
—

 
384,255

 
—

Derivative assets:
 
 
 
 
 
 
 
Interest rate swaps
7,154

 
—

 
7,154

 
—

Total asset recurring fair value measurements
$
1,486,754

 
$
75,989

 
$
1,410,765

 
$
—

 
 
 
 
 
 
 
 
Derivative liabilities:
 
 
 
 
 
 
 
Interest rate swaps
$
85

 
$
—

 
$
85

 
$
—

Total liability recurring fair value measurements
$
85

 
$
—

 
$
85

 
$
—

 
 
 
 
 
 
 
 
Nonrecurring fair value measurements
 

 
 

 
 

 
 

Foreclosed assets
$
388

 
$
—

 
$
—

 
$
388

Impaired loans (2)
9,693

 
—

 
—

 
9,693

Total asset nonrecurring fair value measurements
$
10,081

 
$
—

 
$
—

 
$
10,081

(1)
All mortgage-backed securities are issued and/or guaranteed by U.S. government agencies or U.S. government-sponsored enterprises.
(2)
Impaired loans represent collateral-dependent loans with a specific valuation allowance. Losses on these loans represent charge-offs which are netted against the allowance for loan losses.

Disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, is required when it is practicable to estimate that value.  In cases where quoted market prices are not available, fair values are based on estimates using present value or other estimation techniques.  Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows.  Such techniques and assumptions, as they apply to individual categories of our financial instruments, are as follows:

Cash and cash equivalents - The carrying amount for cash and cash equivalents is a reasonable estimate of those assets’ fair value.

Investment and mortgage - backed securities held to maturity - Fair values for these securities are based on quoted market prices, where available.  If quoted market prices are not available, fair values are based on quoted market prices for similar securities or estimates from independent pricing services.

FHLB stock and other investments - The carrying amount of FHLB stock and other investments is a reasonable estimate of the fair value of those assets.

Loans receivable - For adjustable rate loans that reprice frequently and with no significant change in credit risk, the carrying amounts are a reasonable estimate of those assets’ fair value.  The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.  Nonperforming loans are estimated using discounted cash flow analyses or the underlying value of the collateral where applicable.

Loans held for sale – The fair value of loans held for sale is determined based on expected proceeds, which are based on sales contracts and commitments.

32



Deposit liabilities - The fair value of demand deposits, savings accounts, and certain money market deposits is the amount on demand at the reporting date, which is the carrying value.  Fair values for fixed rate CDs are estimated using a discounted cash flow calculation that applies interest rates currently being offered for deposits of similar remaining maturities.

Federal funds purchased and repurchase agreements - Federal funds purchased generally have original terms to maturity of one day and repurchase agreements generally have terms of less than one year, and therefore both are considered short-term borrowings. Consequently, their carrying value is a reasonable estimate of fair value.

FHLB advances - The fair value of these advances is estimated by discounting the future cash flows using rates at which advances would be made to borrowers with similar credit ratings and for the same remaining maturities.

Subordinated notes - The fair value of the subordinated notes is estimated by discounting future cash flows using estimated rates at which long-term debt would be made to borrowers with similar credit ratings and for the remaining maturities.

Long-term debt - The fair value of the long-term debt is estimated by discounting future cash flows using estimated rates at which long-term debt would be made to borrowers with similar credit ratings and for the remaining maturities.

33


The following tables present our financial assets, financial liabilities, and unrecognized financial instruments measured on a nonrecurring basis at both their respective carrying amounts and estimated fair value (in thousands):

 
 
 
Estimated Fair Value
March 31, 2017
Carrying
Amount
 
Total
 
Level 1
 
Level 2
 
Level 3
Financial Assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
246,994

 
$
246,994

 
$
246,994

 
$
—

 
$
—

Investment Securities:


 


 


 


 


Held to maturity, at carrying value
421,133

 
427,288

 
—

 
427,288

 
—

Mortgage-backed Securities:
 
 
 
 
 
 
 
 
 
Held to maturity, at carrying value
508,660

 
513,121

 
—

 
513,121

 
—

FHLB stock, at cost, and other investments
66,747

 
66,747

 
—

 
66,747

 
—

Loans, net of allowance for loan losses
2,520,433

 
2,601,382

 
—

 
—

 
2,601,382

Loans held for sale
5,303

 
5,303

 
—

 
5,303

 
—

Financial Liabilities:
 
 
 
 
 
 
 
 
 
Deposits
$
3,705,296

 
$
3,701,697

 
$
—

 
$
3,701,697

 
$
—

Federal funds purchased and repurchase agreements
7,814

 
7,814

 
—

 
7,814

 
—

FHLB advances
1,205,856

 
1,206,415

 
—

 
1,206,415

 
—

Subordinated notes, net of unamortized debt issuance costs
98,133

 
100,561

 
—

 
100,561

 
—

Long-term debt , net of unamortized debt issuance costs
60,237

 
45,572

 
—

 
45,572

 
—


 
 
 
Estimated Fair Value
December 31, 2016
Carrying
Amount
 
Total
 
Level 1
 
Level 2
 
Level 3
Financial Assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
169,654

 
$
169,654

 
$
169,654

 
$
—

 
$
—

Investment Securities:


 


 


 


 


Held to maturity, at carrying value
425,810

 
429,912

 
—

 
429,912

 
—

Mortgage-backed Securities:
 
 
 
 
 
 
 

 
 
Held to maturity, at carrying value
511,677

 
514,370

 
—

 
514,370

 
—

FHLB stock, at cost, and other investments
66,592

 
66,592

 
—

 
66,592

 
—

Loans, net of allowance for loan losses
2,538,626

 
2,630,009

 
—

 
—

 
2,630,009

Loans held for sale
7,641

 
7,641

 
—

 
7,641

 
—

Financial Liabilities:
 
 
 
 
 
 
 
 
 
Deposits
$
3,533,076

 
$
3,293,352

 
$
—

 
$
3,293,352

 
$
—

Federal funds purchased and repurchase agreements
7,097

 
7,097

 
—

 
7,097

 
—

FHLB advances
1,309,646

 
1,331,517

 
—

 
1,331,517

 
—

Subordinated notes, net of unamortized debt issuance costs
98,100

 
101,627

 
—

 
101,627

 
—

Long-term debt , net of unamortized debt issuance costs
60,236

 
45,147

 
—

 
45,147

 
—


The fair value estimate of financial instruments for which quoted market prices are unavailable is dependent upon the assumptions used.  Consequently, those estimates cannot be substantiated by comparison to independent markets and, in many cases, could

34


not be realized in immediate settlement of the instruments.  Accordingly, the aggregate fair value amounts presented in the above fair value table do not necessarily represent their underlying value.


10.      Income Taxes

The income tax expense included in the accompanying statements of income consists of the following (in thousands):
 
Three Months Ended
March 31,
 
2017
 
2016
Current income tax expense
$
3,027

 
$
3,785

Deferred income tax (benefit) expense
(19
)
 
(812
)
Income tax expense
$
3,008

 
$
2,973


Net deferred tax assets totaled $26.8 million at March 31, 2017 and $28.9 million at December 31, 2016 .   No valuation allowance for deferred tax assets was recorded at March 31, 2017 or December 31, 2016 , as management believes it is more likely than not that all of the deferred tax assets will be realized in future years. Unrecognized tax benefits were not material at March 31, 2017 or December 31, 2016 .

During the first quarter of 2017, we adopted a new accounting standard that impacted how the income tax effects associated with stock-based compensation are recognized. See “Note 1 - Summary of Significant Accounting and Reporting Policies” for additional information.

We recognized income tax expense of $3.0 million for both the three months ended March 31, 2017 and March 31, 2016 , for an effective tax rate (“ETR”) of 16.7% and 18.0% , respectively. The adoption of the accounting standard above reduced income tax expense by $126,000 and the ETR by 0.7% for the three months ended March 31, 2017. The lower ETR for the three months ended March 31, 2017 was due largely to an increase in tax-exempt income as a percentage of pre-tax income as compared to the same period in 2016 . The ETR differs from the stated rate of 35% during the comparable period primarily due to the effect of tax-exempt income from municipal loans and securities, as well as bank owned life insurance. We file federal income tax returns and certain state tax returns. We are no longer subject to U.S. federal income tax examinations by tax authorities for years before 2013 .

11.      Off-Balance-Sheet Arrangements, Commitments and Contingencies

Financial Instruments with Off-Balance-Sheet Risk . In the normal course of business, we are a party to certain financial instruments with off-balance-sheet risk to meet the financing needs of our customers.  These off-balance-sheet instruments include commitments to extend credit and standby letters of credit.  These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount reflected in the financial statements.  The contract or notional amounts of these instruments reflect the extent of involvement and exposure to credit loss that we have in these particular classes of financial instruments.

Commitments to extend credit are agreements to lend to a customer provided that the terms established in the contract are met.  Commitments generally have fixed expiration dates and may require the payment of fees.  Since some commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers and similarly do not necessarily represent future cash obligations.

Financial instruments with off-balance-sheet risk were as follows (in thousands):
 
At
March 31,
2017
 
At
December 31,
2016
Unused commitments:
 

 
 

Commitments to extend credit
$
666,207

 
$
665,663

Standby letters of credit
8,612

 
9,075

Total
$
674,819

 
$
674,738


35



We apply the same credit policies in making commitments and standby letters of credit as we do for on-balance-sheet instruments.  We evaluate each customer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary, upon extension of credit is based on management’s credit evaluation of the borrower.  Collateral held varies but may include cash or cash equivalents, negotiable instruments, real estate, accounts receivable, inventory, oil, gas and mineral interests, property, plant, and equipment.

Lease Commitments . We lease certain branch facilities and office equipment under operating leases.  It is expected that certain leases will be renewed, or equipment replaced with new leased equipment, as these leases expire.

Securities . In the normal course of business we buy and sell securities. There were $10.5 million and $160,000 of unsettled trades to purchase securities at March 31, 2017 and December 31, 2016 , respectively. There were $57.4 million unsettled trades to sell securities as of March 31, 2017 . As of December 31, 2016 , there were no unsettled trades to sell securities.

Deposits . There were $31.2 million of unsettled issuances of brokered CDs at March 31, 2017 . There were no unsettled issuances of brokered CDs at December 31, 2016 .

Litigation . We are a party to various litigation in the normal course of business.  Management, after consulting with our legal counsel, believes that any liability resulting from litigation will not have a material effect on our financial position, results of operations or liquidity.

36


ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is a discussion of our consolidated financial condition, changes in our financial condition, and results of our operations, and should be read and reviewed in conjunction with the financial statements, and the notes thereto, in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2016 .
Forward-Looking Statements
Certain statements of other than historical fact that are contained in this report may be considered to be “forward-looking statements” within the meaning of and subject to the safe harbor protections of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements are not guarantees of future performance, nor should they be relied upon as representing management’s views as of any subsequent date.  These statements may include words such as “expect,” “estimate,” “project,” “anticipate,” “appear,” “believe,” “could,” “should,” “may,” “will,” “would,” “seek,” “intend,” “probability,” “risk,” “goal,” “objective,” “plans,” “potential,” and similar expressions. Forward-looking statements are statements with respect to our beliefs, plans, expectations, objectives, goals, anticipations, assumptions and estimates about our future performance and are subject to significant known and unknown risks and uncertainties, which could cause our actual results to differ materially from the results discussed in the forward-looking statements.  For example, discussions about trends in asset quality, capital, liquidity, the pace of loan and revenue growth, the Company’s ability to sell nonperforming assets, expense reductions, planned operational efficiencies, earnings and certain market risk disclosures, including the impact of interest rates and other economic factors, are based upon information presently available to management and are dependent on choices about key model characteristics and assumptions and are subject to various limitations.  By their nature, certain of the market risk disclosures are only estimates and could be materially different from what actually occurs in the future.  Accordingly, our results could materially differ from those that have been estimated.  Other factors that could cause actual results to differ materially from those indicated by forward-looking statements include, but are not limited to, the following:
•
general economic conditions, either globally, nationally, in the State of Texas, or in the specific markets in which we operate, including, without limitation, the deterioration of the commercial real estate, residential real estate, construction and development, energy, oil, and gas credit and liquidity markets, which could cause an adverse change in our net interest margin, or a decline in the value of our assets, which could result in realized losses;
•
current or future legislation, regulatory changes or changes in monetary or fiscal policy that adversely affect the businesses in which we are engaged, including the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”), the Federal Reserve’s actions with respect to interest rates, the capital requirements promulgated by the Basel Committee on Banking Supervision (“Basel Committee”) and other regulatory responses to economic conditions;
•
adverse changes in the status or financial condition of the Government-Sponsored Enterprises (the “GSEs”) which impact the GSEs’ guarantees or ability to pay or issue debt;
•
adverse changes in the credit portfolio of other U.S. financial institutions relative to the performance of certain of our investment securities;
•
economic or other disruptions caused by acts of terrorism in the United States, Europe or other areas;
•
changes in the interest rate yield curve such as flat, inverted or steep yield curves, or changes in the interest rate environment that impact interest margins and may impact prepayments on our mortgage-backed securities (“MBS”) portfolio;
•
increases in our nonperforming assets;
•
our ability to maintain adequate liquidity to fund operations and growth;
•
any applicable regulatory limits or other restrictions on Southside Bank’s ability to pay dividends to us;
•
the failure of our assumptions underlying allowance for loan losses and other estimates;
•
the effectiveness of our derivative financial instruments and hedging activities to manage risk;
•
unexpected outcomes of, and the costs associated with, existing or new litigation involving us;
•
changes impacting our balance sheet and leverage strategy;
•
risks related to actual mortgage prepayments diverging from projections;
•
risks related to actual U.S. Agency MBS prepayments exceeding projected prepayment levels;
•
risks related to U.S. Agency MBS prepayments increasing due to U.S. Government programs designed to assist homeowners to refinance their mortgage that might not otherwise have qualified;
•
our ability to monitor interest rate risk;

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•
risks related to the price per barrel of crude oil;
•
significant increases in competition in the banking and financial services industry;
•
changes in consumer spending, borrowing and saving habits;
•
technological changes, including potential cyber-security incidents;
•
execution of future acquisition, reorganization or disposition transactions, including the risk that the anticipated benefits of such transactions are not realized;
•
our ability to increase market share and control expenses;
•
our ability to develop competitive new products and services in a timely manner and the acceptance of such products and services by our customers;
•
the effect of changes in federal or state tax laws;
•
the effect of compliance with legislation or regulatory changes;
•
the effect of changes in accounting policies and practices;
•
credit risks of borrowers, including any increase in those risks due to changing economic conditions;
•
risks related to loans secured by real estate, including the risk that the value and marketability of collateral could decline; and
•
other risks and uncertainties discussed in Part I - “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2016 .

All written or oral forward-looking statements made by us or attributable to us are expressly qualified by this cautionary notice.  We disclaim any obligation to update any factors or to announce publicly the result of revisions to any of the forward-looking statements included herein to reflect future events or developments, unless otherwise required by law.
Critical Accounting Estimates
Our accounting and reporting estimates conform with U.S. generally accepted accounting principles (“GAAP”) and general practices within the financial services industry.  The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.  Actual results could differ from those estimates.  We consider our critical accounting policies to include the following:
Allowance for Losses on Loans .  The allowance for losses on loans represents our best estimate of probable losses inherent in the existing loan portfolio.  The allowance for losses on loans is increased by the provision for losses on loans charged to expense and reduced by loans charged-off, net of recoveries.  The provision for losses on loans is determined based on our assessment of several factors:  reviews and evaluations of specific loans, changes in the nature and volume of the loan portfolio, current economic conditions and the related impact on specific borrowers and industry groups, historical loan loss experience, the level of classified and nonperforming loans and the results of regulatory examinations.
The allowance for loan loss is based on the most current review of the loan portfolio and is a result of multiple processes.  The servicing officer has the primary responsibility for updating significant changes in a customer’s financial position.  Each officer prepares status updates on any credit deemed to be experiencing repayment difficulties which, in the officer’s opinion, would place the collection of principal or interest in doubt.  Our internal loan review department is responsible for an ongoing review of our loan portfolio with specific goals set for the loans to be reviewed on an annual basis.
At each review, a subjective analysis methodology is used to grade the respective loan.  Categories of grading vary in severity from loans that do not appear to have a significant probability of loss at the time of review to loans that indicate a probability that the entire balance of the loan will be uncollectible.  If full collection of the loan balance appears unlikely at the time of review, estimates of future expected cash flows or appraisals of the collateral securing the debt are used to determine the necessary allowances.  The internal loan review department maintains a list of all loans or loan relationships that are graded as having more than the normal degree of risk associated with them.  In addition, a list of specifically reserved loans or loan relationships of $150,000 or more is updated on a quarterly basis in order to properly determine the necessary allowance and keep management informed on the status of attempts to correct the deficiencies noted with respect to the loan.
Loans are considered impaired if, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement.  The measurement of loss on impaired loans is generally based on the fair value of the collateral if repayment is expected solely from the collateral or the present value of the expected future cash flows discounted at the historical effective interest rate stipulated in the loan agreement. In measuring the fair value of the collateral, in addition to relying on third party appraisals, we use assumptions such

38
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as discount rates and methodologies, comparisons to recent sales prices of similar assets, and other assumptions consistent with those that would be utilized by unrelated third parties performing a valuation.
Changes in the financial condition of individual borrowers, economic conditions, historical loss experience and the conditions of the various markets in which collateral may be sold all may affect the required level of the allowance for losses on loans and the associated provision for loan losses.
The allowance for loan losses related to purchase credit impaired (“PCI”) loans is based on an analysis that is performed quarterly to estimate the expected cash flows for each loan deemed PCI. To the extent that the expected cash flows from a PCI loan have decreased since the acquisition date, we establish or increase the allowance for loan losses.
For acquired loans that are not deemed credit impaired at acquisition, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value. Subsequent to the purchase date, the methods utilized to estimate the required allowance for loan losses for these loans is similar to originated loans. The remaining differences between the purchase price and the unpaid principal balance at the date of acquisition are recorded in interest income over the economic life of the loan.
As of March 31, 2017 , our review of the loan portfolio indicated that a loan loss allowance of $18.5 million was appropriate to cover probable losses in the portfolio.
Refer to “Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Loan Loss Experience and Allowance for Loan Losses” and “Note 6 – Loans and Allowance for Probable Loan Losses” in our Annual Report on Form 10-K for the year ended December 31, 2016 for a detailed description of our estimation process and methodology related to the allowance for loan losses.
Estimation of Fair Value .  The estimation of fair value is significant to a number of our assets and liabilities.  In addition, GAAP requires disclosure of the fair value of financial instruments as a part of the notes to the consolidated financial statements.  Fair values for securities are volatile and may be influenced by a number of factors, including market interest rates, prepayment speeds, discount rates and the shape of yield curves.  Fair values for most investment and MBS are based on quoted market prices, where available.  If quoted market prices are not available, fair values are based on the quoted prices of similar instruments or estimates from independent pricing services.  Where there are price variances outside certain ranges from different pricing services for specific securities, those pricing variances are reviewed with other market data to determine which of the price estimates is appropriate for that period. 
Impairment of Investment Securities and Mortgage-backed Securities .  Investment securities and MBS classified as available for sale (“AFS”) are carried at fair value, and the impact of changes in fair value are recorded on our consolidated balance sheet as an unrealized gain or loss in “Accumulated other comprehensive (loss) income,” a separate component of shareholders’ equity.  Securities classified as AFS or held to maturity (“HTM”) are subject to our review to identify when a decline in value is other-than-temporary.  When it is determined that a decline in value is other-than-temporary, the carrying value of the security is reduced to its estimated fair value, with a corresponding charge to earnings for the credit portion and to other comprehensive income for the noncredit portion.  Factors considered in determining whether a decline in value is other-than-temporary include: (1) whether the decline is substantial, the duration of the decline and the reasons for the decline in value; (2) whether the decline is related to a credit event, a change in interest rate or a change in the market discount rate; (3) the financial condition and near-term prospects of the issuer; and (4) whether we have a current intent to sell the security and whether it is not more likely than not that we will be required to sell the security before the anticipated recovery of its amortized cost basis. For certain assets, we consider expected cash flows of the investment in determining if impairment exists.
Defined Benefit Pension Plan . The plan obligations and related assets of our defined benefit pension plan (the “Plan”) and the OmniAmerican Bank Defined Benefit Plan (the “Acquired Plan”) are described in “Note 11 – Employee Benefits” in our Annual Report on Form 10-K for the year ended December 31, 2016 .  Entry into the Plan by new employees was frozen effective December 31, 2005.  Effective December 31, 2006, employee benefits under the Acquired Plan were frozen by Omni. In addition, no new participants may be added to the Acquired Plan. Plan assets, which consist primarily of marketable equity and debt instruments, are valued using observable market quotations.  Plan obligations and the annual pension expense are determined by independent actuaries and through the use of a number of assumptions that are reviewed by management.  Key assumptions in measuring the Plan obligations include the discount rate, the rate of salary increases and the estimated future return on Plan assets.  In determining the discount rate, we utilized a cash flow matching analysis to determine a range of appropriate discount rates for our defined benefit pension and restoration plans.  In developing the cash flow matching analysis, we constructed a portfolio of high quality noncallable bonds (rated AA- or better) to match as close as possible the timing of future benefit payments of the Plans at December 31, 2016 .  Based on this cash flow matching analysis, we were able to determine an appropriate discount rate.
Salary increase assumptions are based upon historical experience and our anticipated future actions. The expected long-term rate of return assumption reflects the average return expected based on the investment strategies and asset allocation on the assets

39
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invested to provide for the Plan’s liabilities. We consider broad equity and bond indices, long-term return projections, and actual long-term historical Plan performance when evaluating the expected long-term rate of return assumption. At March 31, 2017 , the weighted-average actuarial assumptions of the Plan were: a discount rate of 4.23% ; assumed salary increases of 3.50% ; and a long-term rate of return on Plan assets of 7.25% . Material changes in pension benefit costs may occur in the future due to changes in these assumptions.  Future annual amounts could be impacted by changes in the number of Plan participants, changes in the level of benefits provided, changes in the discount rates, changes in the expected long-term rate of return, changes in the level of contributions to the Plan and other factors.
Non-GAAP Financial Measures

Certain non-GAAP measures are used by management to supplement the evaluation of our performance. These include the following fully-taxable equivalent measures: tax-equivalent net interest income, tax-equivalent net interest margin, and tax-equivalent net interest spread, which include the effects of taxable-equivalent adjustments using a federal income tax rate of 35% to increase tax-exempt interest income to a tax-equivalent basis.  Whenever we present a non-GAAP financial measure in an SEC filing, we are also required to present the most directly comparable financial measure calculated and presented in accordance with GAAP and reconcile the differences between the non-GAAP financial measure and such comparable GAAP measure. Tax-equivalent adjustments are reported in notes 2 and 3 to the Average Balances with Average Yields and Rates tables under Results of Operations.

Tax-equivalent net interest income, net interest margin and net interest spread.  Net interest income on a tax-equivalent basis is a non-GAAP measure that adjusts for the tax-favored status of net interest income from loans and investments. We believe this measure to be the preferred industry measurement of net interest income and it enhances comparability of net interest income arising from taxable and tax-exempt sources. The most directly comparable financial measure calculated in accordance with GAAP is our net interest income. Net interest margin on a tax-equivalent basis is net interest income on a tax-equivalent basis divided by average interest-earning assets on a tax-equivalent basis. The most directly comparable financial measure calculated in accordance with GAAP is our net interest margin. Net interest spread on a tax-equivalent basis is the difference in the average yield on average interest-earning assets on a tax equivalent basis and the average rate paid on average interest-bearing liabilities. The most directly comparable financial measure calculated in accordance with GAAP is our net interest spread.

These non-GAAP financial measures should not be considered an alternative to GAAP-basis financial statements, and other bank holding companies may define or calculate these or similar measures differently.

Off-Balance-Sheet Arrangements, Commitments and Contingencies
Financial Instruments with Off-Balance-Sheet Risk . In the normal course of business, we are a party to certain financial instruments with off-balance-sheet risk to meet the financing needs of our customers.  These off-balance-sheet instruments include commitments to extend credit and standby letters of credit.  These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount reflected in the financial statements.  The contract or notional amounts of these instruments reflect the extent of involvement and exposure to credit loss that we have in these particular classes of financial instruments.

Commitments to extend credit are agreements to lend to a customer provided that the terms established in the contract are met.  Commitments generally have fixed expiration dates and may require the payment of fees.  Since some commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers and similarly do not necessarily represent future cash obligations.

Financial instruments with off-balance-sheet risk were as follows (in thousands):
 
At
March 31,
2017
 
At
December 31,
2016
Unused commitments:
 

 
 

Commitments to extend credit
$
666,207

 
$
665,663

Standby letters of credit
8,612

 
9,075

Total
$
674,819

 
$
674,738



40
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We apply the same credit policies in making commitments and standby letters of credit as we do for on-balance-sheet instruments.  We evaluate each customer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary, upon extension of credit is based on management’s credit evaluation of the borrower.  Collateral held varies but may include cash or cash equivalents, negotiable instruments, real estate, accounts receivable, inventory, oil, gas and mineral interests, property, plant, and equipment.

Lease Commitments . We lease certain branch facilities and office equipment under operating leases.  It is expected that certain leases will be renewed, or equipment replaced with new leased equipment, as these leases expire.

Securities . In the normal course of business we buy and sell securities. There were $10.5 million and $160,000 of unsettled trades to purchase securities at March 31, 2017 and December 31, 2016 , respectively. There were $57.4 million unsettled trades to sell securities as of March 31, 2017 . As of December 31, 2016 , there were no unsettled trades to sell securities.

Deposits . There were $31.2 million of unsettled issuances of brokered CDs at March 31, 2017 . There were no unsettled issuances of brokered CDs at December 31, 2016 .

Litigation . We are a party to various litigation in the normal course of business.  Management, after consulting with our legal counsel, believes that any liability resulting from litigation will not have a material effect on our financial position, results of operations or liquidity.

OVERVIEW

Operating Results

During the three months ended March 31, 2017 , our net income increase d $1.5 million , or 10.9% , to $15.0 million compared to the same period in 2016 . The increase was primarily the result of a $1.9 million increase in interest income, a $1.2 million decrease in provision for loan losses, and a $3.5 million decrease in noninterest expense, partially offset by a $3.2 million increase in interest expense and a $1.9 million decrease in noninterest income. Earnings per diluted share increased $0.01 , or 2.0% , to $0.52 for the three months ended March 31, 2017 , from $0.51 for the same period in 2016.

Financial Condition

Our total assets increase d $92.5 million , or 1.7% , to $5.66 billion at March 31, 2017 from $5.56 billion at December 31, 2016 primarily as a result of increases in our cash and cash equivalents, unsettled trades to sell securities, and unsettled issuances of brokered certificate of deposits.  Our securities portfolio decrease d by $43.3 million , or 1.8% , to $2.37 billion , compared to $2.42 billion at December 31, 2016 . Loans decrease d $17.6 million , or 0.7% , to $2.54 billion compared to $2.56 billion at December 31, 2016 . The net decrease in our loans was comprised of decreases in construction loans of $17.8 million , $14.4 million of 1-4 family residential loans, $12.3 million of loans to individuals and $1.2 million of municipal loans, which decreases were partially offset by increase s in commercial real estate loans of $28.3 million .

Our nonperforming assets at March 31, 2017 decrease d to $14.1 million and represented 0.25% of total assets, compared to $15.1 million or 0.27% of total assets at December 31, 2016.  Nonaccruing loans decrease d $1.0 million , or 12.3% , to $7.3 million and the ratio of nonaccruing loans to total loans decrease d to 0.29% at March 31, 2017 compared to 0.32% at December 31, 2016 .  Other Real Estate Owned (“OREO”) increase d to $367,000 at March 31, 2017 from $339,000 at December 31, 2016 . Repossessed assets decrease d to $26,000 at March 31, 2017 from $49,000 at December 31, 2016 .  Restructured loans were $6.4 million at both March 31, 2017 and December 31, 2016 .

Our deposits increase d $172.2 million , or 4.9% , to $3.71 billion at March 31, 2017 from $3.53 billion at December 31, 2016 .  The increase in our deposits during 2017 was primarily the result of an increase in brokered CDs, public fund deposits and noninterest bearing deposits. For the three months ended March 31, 2017 , our non-interest bearing deposits increase d $49.2 million and interest bearing deposits increase d $123.0 million . Total FHLB advances decrease d $103.8 million to $1.21 billion at March 31, 2017 from $1.31 billion at December 31, 2016 .  Short-term FHLB advances increase d $86.4 million to $952.9 million at March 31, 2017 from $866.5 million at December 31, 2016 .  Long-term FHLB advances decrease d $190.2 million to $252.9 million at March 31, 2017 from $443.1 million at December 31, 2016 .

Shareholders’ equity at March 31, 2017 totaled $531.5 million compared to $518.3 million at December 31, 2016 . The 2.5% increase was primarily the result of net income of $15.0 million recorded for the three months ended March 31, 2017 , a decrease in accumulated other comprehensive loss of $3.9 million , net issuance of common stock under employee stock plans of $597,000 ,

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stock compensation expense of $494,000 and common stock issued under our dividend reinvestment plan of $353,000 .  These increase s were partially offset by cash dividends paid of $7.1 million .

Key financial indicators management follows include, but are not limited to, numerous interest rate sensitivity and interest rate risk indicators, credit risk, operations risk, liquidity risk, capital risk, regulatory risk, competition risk, yield curve risk, U.S. Agency MBS prepayment risk, and economic risk indicators.

Balance Sheet Strategy
We utilize wholesale funding and securities to enhance our profitability and balance sheet composition by determining acceptable levels of credit, interest rate and liquidity risk consistent with prudent capital management.  This balance sheet strategy consists of borrowing a combination of long- and short-term funds from the FHLB and, when determined appropriate, issuing brokered CDs.  These funds are invested primarily in U.S. Agency MBS, and to a lesser extent, long-term municipal securities and U.S. Treasury securities.  Although U.S. Agency MBS often carry lower yields than traditional mortgage loans and other types of loans we make, these securities generally (i) increase the overall quality of our assets because of either the implicit or explicit guarantees of the U.S. Government, (ii) are more liquid than individual loans and (iii) may be used to collateralize our borrowings or other obligations.  While the strategy of investing a substantial portion of our assets in U.S. Agency MBS and municipal securities has historically resulted in lower interest rate spreads and margins, we believe the lower operating expenses and reduced credit risk, combined with the managed interest rate risk of this strategy, have enhanced our overall profitability over the last several years.  At this time, we utilize this balance sheet strategy with the goal of enhancing overall profitability by maximizing the use of our capital.
Risks associated with the asset structure we maintain include a lower net interest rate spread and margin when compared to our peers, changes in the slope of the yield curve, which can reduce our net interest rate spread and margin, increased interest rate risk, the length of interest rate cycles, changes in volatility spreads associated with the MBS and municipal securities, the unpredictable nature of MBS prepayments and credit risks associated with the municipal securities.  See “Part I - Item 1A.  Risk Factors – Risks Related to Our Business” in our Annual Report on Form 10-K for the year ended December 31, 2016 , for a discussion of risks related to interest rates.  Our asset structure, net interest spread and net interest margin require us to closely monitor our interest rate risk.  An additional risk is the change in fair value of the AFS securities portfolio as a result of changes in interest rates.  Significant increases in interest rates, especially long-term interest rates, could adversely impact the fair value of the AFS securities portfolio, which could also significantly impact our equity capital.  Due to the unpredictable nature of MBS prepayments, the length of interest rate cycles, and the slope of the interest rate yield curve, net interest income could fluctuate more than simulated under the scenarios modeled by our ALCO and described under “Item 3.  Quantitative and Qualitative Disclosures about Market Risk” in this Quarterly Report on Form 10-Q.
Determining the appropriate size of the balance sheet is one of the critical decisions any bank makes.  Our balance sheet is not merely the result of a series of micro-decisions, but rather the size is controlled based on the economics of assets compared to the economics of funding. The current low interest rate environment and investment and economic landscape requires that we monitor the interest rate sensitivity of the assets driving our growth and closely align ALCO objectives accordingly.
The management of our securities portfolio as a percentage of earning assets is guided by the current economics associated with increasing the securities portfolio, changes in our overall loan and deposit levels, and changes in our wholesale funding levels.  If adequate quality loan growth is not available to achieve our goal of enhancing profitability by maximizing the use of capital, as described above, then we may purchase additional securities, if appropriate, which may cause securities as a percentage of earning assets to increase.  Should we determine that increasing the securities portfolio or replacing the current securities maturities and principal payments is not an efficient use of capital, we may decrease the level of securities through proceeds from maturities, principal payments on MBS or sales.  Our balance sheet strategy is designed such that our securities portfolio should help mitigate financial performance associated with potential business cycles that include slower loan growth and higher credit costs.
During the quarter ended March 31, 2017 , we sold Texas municipal securities, U.S. Agency collateralized mortgage obligations (“CMO”), U.S. Agency commercial mortgage-backed securities (“CMBS”), and U.S. Treasury securities that resulted in an overall gain on the sale of AFS securities of $322,000 . During the first quarter we elected to sell selected long-term CMBS, lower yielding MBS and low balance, short duration MBS. In addition, we sold Texas municipal securities with lower yields and longer durations. During the first quarter of 2017, we sold approximately $12.0 million of our lowest yielding U.S. Treasuries. During the quarter ended March 31, 2017 , we primarily purchased premium CMOs with favorable expected returns in relation to risk. Our total portfolio, comprised of investment and MBS, decrease d from $2.42 billion at December 31, 2016 to $2.37 billion at March 31, 2017 .
At March 31, 2017 , securities decreased as a percentage of assets to 42.0% as compared to 43.4% at December 31, 2016 due to the overall increase in total assets of $92.5 million and the $43.3 million , or 1.8% , decrease in the securities portfolio. The size of the securities portfolio increased during the last quarter of 2016 to offset the interest expense associated with the subordinated

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debt we issued in September 2016. Our balance sheet management strategy is dynamic and will be continually reevaluated as market conditions warrant.  As interest rates, yield curves, MBS prepayments, funding costs, security spreads and loan and deposit portfolios change, our determination of the proper types, amount and maturities of securities to own as well as funding needs and funding sources will continue to be reevaluated.  Should the economics of purchasing securities decrease, we may allow this part of the balance sheet to shrink through run-off or security sales.  However, should the economics become more attractive, we may strategically increase the securities portfolio and the balance sheet.
With respect to liabilities, we continue to utilize a combination of FHLB advances and deposits to achieve our strategy of minimizing cost while achieving overall interest rate risk objectives as well as the liability management objectives of the ALCO. FHLB funding is the primary wholesale funding source we are currently utilizing.
Our FHLB borrowings decrease d 7.9% , or $103.8 million , to $1.21 billion at March 31, 2017 from $1.31 billion at December 31, 2016 . During the three months ended March 31, 2017 , our long-term FHLB advances decrease d $190.2 million , to $252.9 million from $443.1 million at December 31, 2016 . From time to time, the Company may enter into various variable rate advances with the FHLB. These advances totaled $240.0 million at March 31, 2017 and $250.0 million at December 31, 2016 , of which $60.0 million and $230.0 million were considered long-term at March 31, 2017 and December 31, 2016 , respectively. These advances have interest rates ranging from one-month LIBOR plus 0.17% to one-month LIBOR plus 0.278% . Two of the variable rate advances have interest rates of three-month LIBOR minus 25 basis points. In connection with obtaining these advances, the Company entered into various interest rate swap contracts that are treated as cash flow hedges under ASC Topic 815, “Derivatives and Hedging” that effectively converted the variable rate advances to fixed interest rates ranging from 0.932% to 2.345% and original terms ranging from five years to ten years. The cash flows from the swaps are expected to be effective in hedging the variability in future cash flows attributable to fluctuations in the one-month and three-month LIBOR interest rates. During the first quarter of 2017 , we terminated two interest rate swap contracts designated as a cash flow hedges having a total notional value of $ 40.0 million . At the time of termination, we determined that the underlying hedged forecasted transactions were still probable of occurring.
On September 19, 2016 , the Company issued $100.0 million aggregate principal amount of fixed-to-floating rate subordinated notes that mature on September 30, 2026 . This debt initially bears interest at a fixed rate of 5.50% through September 29, 2021 and thereafter, adjusts quarterly at a floating rate equal to three-month LIBOR plus 429.7 basis points. The proceeds from the sale of the subordinated notes were used for general corporate purposes, which included advances to Southside Bank to finance its activities. The unamortized discount and debt issuance costs deducted from the subordinated notes totaled approximately $1.9 million at March 31, 2017 .
Our brokered CDs increase d from $35.5 million at December 31, 2016 to $120.5 million at March 31, 2017 , or 239.3% , due to ALCO objectives. At March 31, 2017 , approximately $114.7 million of our brokered CDs were non-callable with a weighted average cost of 75 basis points and remaining maturities of one to thirteen months. The remaining $5.7 million were long-term brokered CDs that mature within three years and have short-term calls that we control.  Our wholesale funding policy currently allows maximum brokered CDs of $180 million; however, this amount could be increased to match changes in ALCO objectives.  The potential higher interest expense and lack of customer loyalty are risks associated with the use of brokered CDs.  
During the three months ended March 31, 2017 , decrease s in FHLB advances offset by the increase in deposits resulted in a slight decrease in our total wholesale funding as a percentage of deposits, not including brokered deposits, to 37.0% at March 31, 2017 from 38.5% at December 31, 2016 .
Results of Operations

Our results of operations are dependent primarily on net interest income, which is the difference between the interest income earned on assets (loans and investments) and interest expense due on our funding sources (deposits and borrowings) during a particular period.  Results of operations are also affected by our noninterest income, provision for loan losses, noninterest expenses and income tax expense.  General economic and competitive conditions, particularly changes in interest rates, changes in interest rate yield curves, prepayment rates of MBS and loans, repricing of loan relationships, government policies and actions of regulatory authorities also significantly affect our results of operations.  Future changes in applicable law, regulations or government policies may also have a material impact on us.




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RESULTS OF OPERATIONS
The “Average Balances with Average Yields and Rates” table that follows provides an analysis of net interest income for the three months ended March 31, 2017 and 2016 and details the components of the change in net interest income for the three months ended March 31, 2017 compared to the same period in the prior year (dollars in thousands).
 
Average Balances with Average Yields and Rates
 
 
 
 
 
(unaudited)
 
 
 
 
 
 
 
 
 
Three Months Ended
 
 
 
 
 
March 31, 2017
 
March 31, 2016
 
Avg Balance
 
Interest
 
Avg Yield/Rate
 
Avg Balance
 
Interest
 
Avg Yield/Rate
ASSETS
 
 
 
 
 
 
 
 
 
 
 
Loans (1) (2)
$
2,549,230

 
$
28,241

 
4.49
%
 
$
2,434,837

 
$
28,793

 
4.76
%
Loans held for sale
7,023

 
48

 
2.77
%
 
3,581

 
32

 
3.59
%
Securities:
 
 
 
 
 
 
 
 
 
 
 
Investment securities (taxable) (4)
86,511

 
377

 
1.77
%
 
41,659

 
214

 
2.07
%
Investment securities (tax-exempt) (3) (4)
779,772

 
9,929

 
5.16
%
 
635,766

 
8,494

 
5.37
%
Mortgage-backed and related securities (4)
1,570,510

 
10,045

 
2.59
%
 
1,454,343

 
9,391

 
2.60
%
Total securities
2,436,793

 
20,351

 
3.39
%
 
2,131,768

 
18,099

 
3.41
%
FHLB stock, at cost, and other investments
66,547

 
298

 
1.82
%
 
55,116

 
217

 
1.58
%
Interest earning deposits
162,235

 
346

 
0.86
%
 
51,246

 
70

 
0.55
%
Federal funds sold
7,217

 
14

 
0.79
%
 
—

 
—

 
—

Total earning assets
5,229,045

 
49,298

 
3.82
%
 
4,676,548

 
47,211

 
4.06
%
Cash and due from banks
53,528

 
 
 
 
 
55,732

 
 
 
 
Accrued interest and other assets
350,729

 
 
 
 
 
370,022

 
 
 
 
Less:  Allowance for loan losses
(18,130
)
 
 
 
 
 
(20,088
)
 
 
 
 
Total assets
$
5,615,172

 
 
 
 
 
$
5,082,214

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
 
 
 
 
 
 
 
Savings deposits
$
252,744

 
92

 
0.15
%
 
$
235,492

 
65

 
0.11
%
Time deposits
927,610

 
2,227

 
0.97
%
 
915,316

 
1,723

 
0.76
%
Interest bearing demand deposits
1,707,996

 
1,962

 
0.47
%
 
1,717,717

 
1,468

 
0.34
%
Total interest bearing deposits
2,888,350

 
4,281

 
0.60
%
 
2,868,525

 
3,256

 
0.46
%
Short-term interest bearing liabilities
1,007,546

 
2,065

 
0.83
%
 
413,985

 
696

 
0.68
%
Long-term interest bearing liabilities – FHLB Dallas
301,775

 
1,402

 
1.88
%
 
566,825

 
2,039

 
1.45
%
Subordinated notes (5)
98,117

 
1,393

 
5.76
%
 
—

 
—

 
—

Long-term debt  (6)
60,237

 
467

 
3.14
%
 
60,232

 
405

 
2.70
%
Total interest bearing liabilities
4,356,025

 
9,608

 
0.89
%
 
3,909,567

 
6,396

 
0.66
%
Noninterest bearing deposits
693,729

 
 
 
 
 
672,865

 
 
 
 
Accrued expenses and other liabilities
39,960

 
 
 
 
 
45,390

 
 
 
 
Total liabilities
5,089,714

 
 
 
 
 
4,627,822

 
 
 
 
Shareholders’ equity
525,458

 
 
 
 
 
454,392

 
 
 
 
Total liabilities and shareholders’ equity
$
5,615,172

 
 
 
 
 
$
5,082,214

 
 
 
 
Net interest income
 
 
$
39,690

 
 
 
 
 
$
40,815

 
 
Net interest margin on average earning assets
 
 
 
 
3.08
%
 
 
 
 
 
3.51
%
Net interest spread
 
 
 
 
2.93
%
 
 
 
 
 
3.40
%

(1)
Interest on loans includes net fees on loans that are not material in amount.
(2)
Interest income includes taxable-equivalent adjustments of $1,035 and $1,060 for the three months ended March 31, 2017 and 2016 , respectively. See “Non-GAAP Financial Measures.”
(3)
Interest income includes taxable-equivalent adjustments of $3,375 and $3,139 for the three months ended March 31, 2017 and 2016 , respectively. See “Non-GAAP Financial Measures.”
(4)
For the purpose of calculating the average yield, the average balance of securities is presented at historical cost.
(5)
The unamortized discount and debt issuance costs reflected in the carrying amount of the subordinated notes totaled approximately $1.9 million for the three months ended March 31, 2017 .
(6)
Represents issuance of junior subordinated debentures. In connection with the adoption of ASU 2015-03 that requires unamortized debt issuance costs be presented as a direct deduction from the related debt liability, our average long-term debt for the three months ended March 31, 2017 and 2016 reflect unamortized debt issuance costs of $74,000 and $79,000, respectively.

Note: As of March 31, 2017 and 2016 , loans totaling $7,261 and $21,927 , respectively, were on nonaccrual status. Our policy is to reverse previously accrued but unpaid interest on nonaccrual loans; thereafter, interest income is recorded to the extent received when appropriate.

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Net Interest Income

Net interest income is one of the principal sources of a financial institution’s earnings stream and represents the difference or spread between interest and fee income generated from interest earning assets and the interest expense paid on deposits and borrowed funds.  Fluctuations in interest rates or interest rate yield curves, as well as repricing characteristics and volume, and changes in the mix of interest earning assets and interest bearing liabilities, materially impact net interest income.
Analysis of Changes in Interest Income and Interest Expense
The following table compares the dollar amount of increase (decrease) in interest income and interest expense resulting from changes in the volume of interest earning assets and interest bearing liabilities and from changes in yields/rates for the periods shown (in thousands):
 
Three Months Ended March 31,
2017 Compared to 2016
 
Average
Volume
 
Average
Yield/Rate
 
Increase
(Decrease)
INTEREST INCOME:
 
 
 
 
 
Loans (1)
$
1,316

 
$
(1,868
)
 
$
(552
)
Loans held for sale
25

 
(9
)
 
16

Investment securities (taxable)
200

 
(37
)
 
163

Investment securities (tax exempt) (1)
1,849

 
(414
)
 
1,435

Mortgage-backed securities
744

 
(90
)
 
654

FHLB stock, at cost and other investments
49

 
32

 
81

Interest earning deposits
219

 
57

 
276

Federal funds sold
14

 
—

 
14

Total interest income
4,416

 
(2,329
)
 
2,087

INTEREST EXPENSE:
 
 
 
 
 
Savings deposits
5

 
22

 
27

Time deposits
23

 
481

 
504

Interest bearing demand deposits
(8
)
 
502

 
494

Short-term interest bearing liabilities
1,188

 
181

 
1,369

Long-term FHLB advances
(1,125
)
 
488

 
(637
)
Subordinated notes
1,393

 
—

 
1,393

Long-term debt
—

 
62

 
62

Total interest expense
1,476

 
1,736

 
3,212

Net interest income
$
2,940

 
$
(4,065
)
 
$
(1,125
)
(1)
Interest yields on loans and securities that are nontaxable for federal income tax purposes are presented on a taxable equivalent basis. See “Non-GAAP Financial Measures.”
Note:  Volume/Yield/Rate variances (change in volume times change in yield/rate) have been allocated to amounts attributable to changes in volumes and to changes in yields/rates in proportion to the amounts directly attributable to those changes.
Net interest income for the three months ended March 31, 2017 decrease d $1.3 million , or 3.6% , to $35.3 million , compared to $36.6 million for the same period in 2016 . The decrease in net interest income for the three months ended March 31, 2017 , compared to the same period in 2016 , was the result of the increase in interest expense of $3.2 million associated with short- and long-term obligations and deposits, which were partially offset by an increase in interest income of $1.9 million , which was primarily a result of the increase in interest income from the securities portfolio. For the three months ended March 31, 2017 , our net interest margin decreased to 3.08% for the three months ended March 31, 2017 , compared to 3.51% for the same period in 2016 and our net interest spread decreased to 2.93% , compared to 3.40% for the same period in 2016 , due to higher rates paid on interest-bearing liabilities along with a decrease in the yield on earning assets.
Total interest income increase d $1.9 million , or 4.4% , to $44.9 million during the three months ended March 31, 2017 , compared to $43.0 million during the same period in 2016 . The increase was attributable to the increase in average earning assets of $552.5 million , or 11.8% , to $5.23 billion for the three months ended March 31, 2017 from $4.68 billion for the same period in 2016 , which was partially offset by the decrease in the average yield on earning assets to 3.82% for the three months ended March 31, 2017 from 4.06% for the three months ended March 31, 2016 . The decrease in the yield on earning assets during the three months ended March 31, 2017 is the result of a decrease in the average yield on loans which decreased from 4.76% for the three months ended March 31, 2016 to 4.49% for the three months ended March 31, 2017 , due to the $1.3 million recovery of interest income on the

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payoff of a long-term nonaccrual loan during the first quarter of 2016 and a decrease in purchase accounting accretion for the three months ended March 31, 2017.
Total interest expense increase d $3.2 million , or 50.2% , to $9.6 million during the three months ended March 31, 2017 , compared to $6.4 million during the same period in 2016 .  The increase in interest expense for the three months ended March 31, 2017 was attributable to the increase in average interest bearing liabilities of $446.5 million , or 11.4% , from $3.91 billion during the three months ended March 31, 2016 to $4.36 billion during the three months ended March 31, 2017 , and an increase in the average rate paid on interest bearing liabilities to 0.89% for the three months ended March 31, 2017 , from 0.66% for the three months ended March 31, 2016 .  The increase in average interest-bearing liabilities was primarily the result of the increase in short-term interest bearing liabilities, the issuance of the subordinated notes and to a lesser extent, deposits, partially offset by a decrease in long-term interest bearing liabilities. The increase in rates paid on interest bearing liabilities was a direct result of the subordinated debt issuance, and to a lesser extent, the decrease in purchase accretion on the certificate of deposit premium, both having occurred during the third quarter of 2016.


Noninterest Income
Noninterest income consists of revenue generated from a broad range of financial services and activities and other fee generating programs that we either provide or in which we participate. The following table details the categories included in noninterest income (in thousands):
 
 
Three Months Ended
March 31,
 
 
2017
 
2016
Deposit services
 
$
5,114

 
$
5,085

Net gain on sale of securities available for sale
 
322

 
2,441

Gain on sale of loans
 
701

 
643

Trust income
 
890

 
855

Bank owned life insurance income
 
634

 
674

Brokerage services
 
547

 
575

Other noninterest income
 
1,465

 
1,323

Total noninterest income
 
$
9,673

 
$
11,596

Noninterest income was $9.7 million for the three months ended March 31, 2017 , compared to $11.6 million for the same period in 2016 , a decrease of $1.9 million , or 16.6% .  The decrease for the three months ended March 31, 2017 when compared to the same period in 2016 was primarily due to a decrease in net gain on sale of securities available for sale which was slightly offset by increases in other noninterest income. We sold U.S. Agency CMOs, U.S. Agency CMBS, Texas municipal securities and U.S. Treasury securities that resulted in a net gain on sale of AFS securities of $322,000 for the three months ended March 31, 2017 . The increase in other noninterest income was primarily attributable to increases in income from customer derivatives and mortgage servicing fee income, which was partially offset by a decrease in the return on other investments.

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Noninterest Expense
We incur certain types of noninterest expenses associated with the operation of our various business activities. The following table details the categories included in noninterest expense (in thousands):
 
 
Three Months Ended
March 31,
 
 
2017
 
2016
Salaries and employee benefits
 
$
15,919

 
$
17,732

Occupancy expense
 
2,863

 
3,335

Advertising, travel & entertainment
 
583

 
685

ATM and debit card expense
 
927

 
712

Professional fees
 
939

 
1,338

Software and data processing expense
 
725

 
749

Telephone and communications
 
526

 
484

FDIC insurance
 
441

 
638

Other noninterest expense
 
2,935

 
3,734

Total noninterest expense
 
$
25,858

 
$
29,407

Noninterest expense was $25.9 million for the three months ended March 31, 2017 , compared to $29.4 million for the same period in 2016 , representing a decrease of $3.5 million , or 12.1% . The decrease for the three months ended March 31, 2017 was primarily the result of a decrease in salary and employee benefits, occupancy expense, and professional fees and other noninterest expense.
Salary and employee benefits decreased due to a decrease in retirement expense and to a lesser extent, direct salary expense, partially offset by an increase in health insurance expense. Retirement expense decreased $1.9 million, or 74.6%, most of which was related to the acceptance of early retirement packages by 16 employees during the first quarter of 2016. Health insurance expense increased $196,000, or 15.1%, in the first quarter of 2017 compared to the same period last year. We have a self-insured health plan which is supplemented with stop loss insurance policies.  Health insurance costs are rising nationwide and our health insurance costs may continue to increase during the remainder of 2017 .
Occupancy expense decreased during the first quarter of 2017 due to lower rent expense as a result of early lease terminations during 2016. Professional fees decreased due to less expense in 2017 associated with the process improvement and re-branding efforts initiated in January 2016. The decreases in other noninterest expense were primarily due to a decrease in the provision expense for losses on unfunded loan commitments, other real estate owned ("OREO"), check card losses and a decrease in the core deposit intangible amortization expense.
Income Taxes
During the first quarter of 2017, we adopted a new accounting standard that impacted how the income tax effects associated with stock-based compensation are recognized. See “Note 1 - Summary of Significant Accounting and Reporting Policies” for additional information.
Pre-tax income for the three months ended March 31, 2017 was $18.0 million , compared to $16.5 million for the same period in 2016 .  We recorded income tax expense of $3.0 million for the three months ended March 31, 2017 and 2016. The adoption of the accounting standard above reduced income tax expense by $126,000 and the ETR by 0.7% for the three months ended March 31,2017. The effective tax rate (“ETR”) as a percentage of pre-tax income was 16.7% for the three months ended March 31, 2017 , compared to an ETR as a percentage of pre-tax income of 18.0% for the same period in 2016 .  The decrease in the ETR for the three months ended March 31, 2017 was due to an increase in tax-exempt income as a percentage of pre-tax income, as compared to the same periods in 2016 .  The ETR differs from the stated rate of 35% during the comparable period primarily due to the effect of tax-exempt income from municipal loans and securities, as well as bank owned life insurance.
Net deferred tax assets totaled $26.8 million at March 31, 2017 , as compared to $28.9 million at December 31, 2016 . The $2.1 million decrease in deferred tax assets was due primarily to the decrease in the unrealized loss in the AFS securities portfolio. No valuation allowance for deferred tax assets was recorded at March 31, 2017 or December 31, 2016 , as management believes it is more likely than not that all of the deferred tax assets will be realized in future years.
Liquidity and Interest Rate Sensitivity
Liquidity management involves our ability to convert assets to cash with a minimum risk of loss to enable us to meet our obligations to our customers at any time.  This means addressing (1) the immediate cash withdrawal requirements of depositors and other

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fund providers; (2) the funding requirements of all lines and letters of credit; and (3) the short-term credit needs of customers.  Liquidity is provided by short-term investments that can be readily liquidated with a minimum risk of loss.  Cash, interest earning deposits and short-term investments with maturities or repricing characteristics of one year or less continue to be a substantial percentage of our total assets.  At March 31, 2017 , these investments were 7.7% of total assets, as compared with 7.2% for December 31, 2016 and 11.2% for March 31, 2016 .  The increase to 7.7% at March 31, 2017 is primarily reflective of increases in interest earning deposits. Liquidity is further provided through the matching, by time period, of rate sensitive interest earning assets with rate sensitive interest bearing liabilities.  Southside Bank has three unsecured lines of credit for the purchase of overnight federal funds at prevailing rates with Frost Bank, TIB-The Independent Bankers Bank and Comerica Bank for $30.0 million, $15.0 million and $7.5 million, respectively.  There were no federal funds purchased at March 31, 2017 .  Southside Bank has a $5.0 million line of credit with Frost Bank to be used to issue letters of credit and at March 31, 2017 , we had one outstanding letter of credit for $195,000.  At March 31, 2017 , the amount of additional funding Southside Bank could obtain from FHLB, collateralized by FHLB stock, nonspecified loans and securities, was approximately $753.7 million, net of FHLB stock purchases required.  Southside Bank currently has no outstanding letters of credit from FHLB as collateral for a portion of its public fund deposits.
Interest rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of new interest income through periods of changing interest rates.  The ALCO closely monitors various liquidity ratios and interest rate spreads and margins.  The ALCO performs interest rate simulation tests that apply various interest rate scenarios including immediate shocks and market value of portfolio equity (“MVPE”) with interest rates immediately shocked plus and minus 200 basis points to assist in determining our overall interest rate risk and the adequacy of our liquidity position.  In addition, the ALCO utilizes a simulation model to determine the impact on net interest income of several different interest rate scenarios.  By utilizing this technology, we can determine changes that need to be made to the asset and liability mix to minimize the change in net interest income under these various interest rate scenarios. See Part I - “Item 3. Quantitative and Qualitative Disclosures about Market Risk” in this Quarterly Report on Form 10-Q.

Capital Resources
Our total shareholders’ equity at March 31, 2017 was $531.5 million , representing an increase of 2.5% , or $13.2 million , from December 31, 2016 , and represented 9.4% of total assets at March 31, 2017 compared to 9.3% of total assets at December 31, 2016 .
Increases to our shareholders’ equity consisted of net income of $15.0 million , a decrease in accumulated other comprehensive loss of $3.9 million , net issuance of common stock under employee stock plans of $597,000 , stock compensation expense of $494,000 and common stock ( 10,433 shares) issued pursuant to our dividend reinvestment plan of $353,000 .  These increase s were partially offset by cash dividends paid of $7.1 million .
As a result of regulations, which became applicable to the Company and the Bank on January 1, 2015, we are required to comply with higher minimum capital requirements (the “Updated Capital Rules”). The Updated Capital Rules made substantial changes to previous capital standards. Among other things, the regulations (i) introduced a new capital requirement known as “Common Equity Tier 1” (“CET1”), (ii) stated that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting certain requirements, (iii) defined CET1 to require that most deductions and adjustments to regulatory capital measures be made to CET1 and not to the other components of capital and (iv) revised the scope of the deductions and adjustments from capital as compared to regulations that previously applied to the Company and other banking organizations.
The Updated Capital Rules also established the following minimum capital ratios, which started to phase in on January 1, 2015: 4.5 percent CET1 to risk-weighted assets; 6.0 percent Tier 1 capital to risk-weighted assets; 8.0 percent total capital to risk-weighted assets; and 4.0 percent Tier 1 leverage ratio to average consolidated assets. In addition, the Updated Capital Rules also introduced a minimum “capital conservation buffer” equal to 2.5% of an organization’s total risk-weighted assets, which exists in addition to the required minimum CET1, Tier 1, and total capital ratios. The “capital conservation buffer,” which must consist entirely of CET1, is designed to absorb losses during periods of economic stress. The Updated Capital Rules provide for a number of deductions from and adjustments to CET1, which include the requirement that mortgage servicing rights, deferred tax assets arising from temporary differences that could not be realized through net operating loss carry-backs and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1.
Under the previous capital framework, the effects of accumulated other comprehensive income items included in shareholders’ equity under U.S. GAAP were excluded for the purposes of determining capital ratios. Under the Updated Capital Rules, we elected to permanently exclude capital in accumulated other comprehensive income in Common Equity Tier 1 capital, Tier 1 capital, and Total capital to risk-weighted assets and Tier 1 capital to adjusted quarterly average assets.

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Under the Updated Capital Rules, certain hybrid securities, such as trust preferred securities, do not qualify as Tier 1 capital. For bank holding companies that had assets of less than $15 billion as of December 31, 2009, which includes Southside, trust preferred securities issued prior to May 19, 2010 can be treated as Tier 1 capital to the extent that they do not exceed 25% of Tier 1 capital after the application of capital deductions and adjustments.
Failure to meet minimum capital requirements under the Updated Capital Rules could result in certain mandatory and possibly additional discretionary actions by our regulators that, if undertaken, could have a direct material effect on our financial statements. Management believes that, as of March 31, 2017 , we met all capital adequacy requirements to which we were subject.
The Federal Deposit Insurance Act requires bank regulatory agencies to take “prompt corrective action” with respect to FDIC-insured depository institutions that do not meet minimum capital requirements.  A depository institution’s treatment for purposes of the prompt corrective action provisions will depend on how its capital levels compare to various capital measures and certain other factors, as established by regulation.  Prompt corrective action and other discretionary actions could have a direct material effect on our financial statements.
It is management’s intention to maintain our capital at a level acceptable to all regulatory authorities and future dividend payments will be determined accordingly.  Regulatory authorities require that any dividend payments made by either us or the Bank not exceed earnings for that year.  Accordingly, shareholders should not anticipate a continuation of our cash dividend payments simply because of the existence of a dividend reinvestment program.  The payment of dividends will depend upon future earnings, our financial condition, and other related factors including the discretion of our board of directors.
To be categorized as well capitalized we must maintain minimum Common Equity Tier 1 risk-based, Tier 1 risk-based, Total capital risk-based and Tier 1 leverage ratios as set forth in the following table:
 
Actual
 
For Capital
Adequacy Purposes
 
To Be Well Capitalized
Under Prompt
Corrective Actions
Provisions
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Amount
March 31, 2017
(dollars in thousands)
Common Equity Tier 1 (to Risk Weighted Assets)
 

 
 

 
 

 
 

 
 

 
 

Consolidated
$
468,396

 
14.58
%
 
$
144,598

 
4.50
%
 
N/A

 
N/A

Bank Only
$
583,575

 
18.16
%
 
$
144,592

 
4.50
%
 
$
208,856

 
6.50
%
 
 
 
 
 
 
 
 
 
 
 
 
Tier 1 Capital (to Risk Weighted Assets)


 


 


 


 


 


Consolidated
$
525,036

 
16.34
%
 
$
192,797

 
6.00
%
 
N/A

 
N/A

Bank Only
$
583,575

 
18.16
%
 
$
192,790

 
6.00
%
 
$
257,053

 
8.00
%
 
 
 
 
 
 
 
 
 
 
 
 
Total Capital (to Risk Weighted Assets)


 


 


 


 


 


Consolidated
$
643,106

 
20.01
%
 
$
257,062

 
8.00
%
 
N/A

 
N/A

Bank Only
$
603,512

 
18.78
%
 
$
257,053

 
8.00
%
 
$
321,316

 
10.00
%
 
 
 
 
 
 
 
 
 
 
 
 
Tier 1 Capital (to Average Assets) (1)


 


 


 


 


 


Consolidated
$
525,036

 
9.51
%
 
$
220,800

 
4.00
%
 
N/A

 
N/A

Bank Only
$
583,575

 
10.58
%
 
$
220,721

 
4.00
%
 
$
275,901

 
5.00
%

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Actual
 
For Capital
Adequacy Purposes
 
To Be Well Capitalized
Under Prompt
Corrective Actions
Provisions
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
December 31, 2016
(dollars in thousands)
Common Equity Tier 1 (to Risk Weighted Assets)
 

 
 

 
 

 
 

 
 

 
 

Consolidated
$
461,158

 
14.64
%
 
$
141,759

 
4.50
%
 
N/A

 
N/A

Bank Only
$
566,423

 
17.98
%
 
$
141,734

 
4.50
%
 
$
204,726

 
6.50
%
 
 
 
 
 
 
 
 
 
 
 
 
Tier 1 Capital (to Risk Weighted Assets)
 
 
 
 
 
 
 
 
 
 
 
Consolidated
$
515,831

 
16.37
%
 
$
189,013

 
6.00
%
 
N/A

 
N/A

Bank Only
$
566,423

 
17.98
%
 
$
188,978

 
6.00
%
 
$
251,971

 
8.00
%
 
 
 
 
 
 
 
 
 
 
 
 
Total Capital (to Risk Weighted Assets)
 

 
 

 
 

 
 

 
 

 
 

Consolidated
$
633,289

 
20.10
%
 
$
252,017

 
8.00
%
 
N/A

 
N/A

Bank Only
$
585,781

 
18.60
%
 
$
251,971

 
8.00
%
 
$
314,964

 
10.00
%
 
 
 
 
 
 
 
 
 
 
 
 
Tier 1 Capital (to Average Assets) (1)


 


 


 


 


 


Consolidated
$
515,831

 
9.46
%
 
$
218,029

 
4.00
%
 
N/A

 
N/A

Bank Only
$
566,423

 
10.40
%
 
$
217,892

 
4.00
%
 
$
272,365

 
5.00
%
(1)
Refers to quarterly average assets as calculated in accordance with policies established by bank regulatory agencies.
Management believes that, as of March 31, 2017 , Southside Bancshares and Southside Bank would meet all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis as if such requirements were currently in effect.

The table below summarizes our key equity ratios for the three months ended March 31, 2017 and 2016 :
 
Three Months Ended
March 31,
 
2017
 
2016
Return on Average Assets
1.08
%
 
1.07
%
Return on Average Shareholders’ Equity
11.57

 
11.96

Dividend Payout Ratio – Basic
48.08

 
45.10

Dividend Payout Ratio – Diluted
48.08

 
45.10

Average Shareholders’ Equity to Average Total Assets
9.36

 
8.94




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Composition of Loans
One of our main objectives is to seek attractive lending opportunities in Texas, primarily in the counties in which we operate.  Refer to “Part I - Item 1. Business - Market Area” in our Annual Report on Form 10-K for the year ended December 31, 2016 for a discussion of our primary market area and the geographic concentration of our loan portfolio as of December 31, 2016 .  There were no substantial changes in these concentrations during the three months ended March 31, 2017 .  Substantially all of our loan originations are made to borrowers who live in and conduct business in the counties in Texas in which we operate or adjoin, with the exception of municipal loans, which are made almost entirely in Texas.  Municipal loans are made to municipalities, counties, school districts and colleges primarily throughout the state of Texas.
Total loans decrease d $17.6 million , or 0.7% , to $2.54 billion at March 31, 2017 from $2.56 billion at December 31, 2016 , and increase d $95.7 million , or 3.9% , from $2.44 billion at March 31, 2016 .  Average loans increase d $114.4 million , or 4.7% , for the three months ended March 31, 2017 when compared to the same period in 2016 .
The banking industry is affected by general economic conditions such as interest rates, inflation, recession, unemployment and other factors beyond our control.  During the last thirty years the Texas economy has continued to diversify, decreasing the overall impact of fluctuations in oil and gas prices; however, the oil and gas industry is still a significant component of the Texas economy.  Since 2010, economic growth and business activity across a wide range of industries and regions in the U.S. has been slow and uneven. During a majority of that time economic growth and business activity in Texas exceeded the U.S. average. However in 2014, decisions by certain members of the Organization of Petroleum Exporting Countries (“OPEC”) to maintain higher crude oil production levels, combined with increased production levels in the United States, led to increased global oil supplies which has resulted in significant declines in market oil prices. Decreased market oil prices have compressed margins for many U.S. and Texas-based oil producers, particularly those that utilize higher-cost production technologies such as hydraulic fracking and horizontal drilling, as well as oilfield service providers, energy equipment manufacturers and transportation suppliers, among others. As of April 24, 2017, the price per barrel of crude oil was approximately $49 compared to approximately $98 as of December 31, 2013. A prolonged period of low oil prices could have a negative impact on the U.S. economy and, in particular, the economies of energy-dominant states such as Texas. Energy loans comprised approximately 1.14% and 1.09% of our loan portfolio at March 31, 2017 and December 31, 2016 , respectively. We cannot predict whether current economic conditions will improve, remain the same or decline.  A decline in credit markets generally could adversely affect our financial condition and results of operation if we are unable to extend credit or sell loans into the secondary market.

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The following table sets forth loan totals by class for the periods presented:
 
At
March 31,
2017
 
At
December 31,
2016
 
At
March 31,
2016
 
(in thousands)
Real Estate Loans:
 

 
 

 
 

Construction
$
362,367

 
$
380,175

 
$
464,750

1-4 Family Residential
622,881

 
637,239

 
644,826

Commercial
974,307

 
945,978

 
657,962

Commercial Loans
176,908

 
177,265

 
233,857

Municipal Loans
297,417

 
298,583

 
286,217

Loans to Individuals
105,038

 
117,297

 
155,619

Total Loans
$
2,538,918

 
$
2,556,537

 
$
2,443,231

Construction loans decrease d $17.8 million , or 4.7% , to $362.4 million at March 31, 2017 from $380.2 million at December 31, 2016 , and decrease d $102.4 million , or 22.0% , from $464.8 million at March 31, 2016 . Our construction loans decreased during the three months ended March 31, 2017 due to pay offs and transfers to permanent financing, more than offsetting new loans and advances on existing construction projects.
1-4 family residential loans decrease d $14.4 million , or 2.3% , to $622.9 million at March 31, 2017 from $637.2 million at December 31, 2016 , and decrease d $21.9 million , or 3.4% , from $644.8 million at March 31, 2016 due primarily to payoffs in excess of originations.
Commercial real estate loans increase d $28.3 million , or 3.0% , to $974.3 million at March 31, 2017 from $946.0 million at December 31, 2016 , and increase d $316.3 million , or 48.1% , from $658.0 million at March 31, 2016 . Our commercial real estate loans continued to increase during the three months ended March 31, 2017 primarily as a result of providing permanent financing on completed construction projects and continued growth in our Austin and Dallas-Fort Worth markets.
Commercial loans decrease d $357,000 , or 0.2% , to $176.9 million at March 31, 2017 from $177.3 million at December 31, 2016 , and decrease d $56.9 million , or 24.4% , from $233.9 million at March 31, 2016 due primarily to payoffs in excess of originations.
Municipal loans decrease d $1.2 million , or 0.4% , to $297.4 million at March 31, 2017 from $298.6 million at December 31, 2016 , and increase d $11.2 million , or 3.9% , from $286.2 million at March 31, 2016 .
Loans to individuals decrease d $12.3 million , or 10.5% , to $105.0 million at March 31, 2017 , from $117.3 million at December 31, 2016 , and decrease d $50.6 million , or 32.5% , from $155.6 million at March 31, 2016 , which primarily reflects the continued roll-off of the indirect automobile loan portfolio acquired from Omni.
Loan Loss Experience and Allowance for Loan Losses
The allowance for loan losses is based on the most current review of the loan portfolio and is a result of multiple processes.  First, we utilize historical net charge-off data to establish general reserve amounts for each class of loans. The historical charge-off figure is further adjusted through qualitative factors that include general trends in past dues, nonaccruals and classified loans to more effectively and promptly react to both positive and negative movements not reflected in historical data. Second, our lenders have the primary responsibility for identifying problem loans based on customer financial stress and underlying collateral.  These recommendations are reviewed by senior loan administration, the special assets department and the loan review department on a monthly basis.  Third, the loan review department independently reviews the portfolio on an annual basis.  The loan review department follows a board-approved annual loan review scope.  The loan review scope encompasses a number of considerations including the size of the loan, the type of credit extended, the seasoning of the loan and the performance of the loan.  The loan review scope, as it relates to size, focuses more on larger dollar loan relationships, typically aggregate debt of $500,000 or greater.  The loan review officer also reviews specific reserves compared to general reserves to determine trends in comparative reserves as well as losses not reserved for prior to charge-off to determine the effectiveness of the specific reserve process.
At each review, a subjective analysis methodology is used to grade the respective loan.  Categories of grading vary in severity from loans that do not appear to have a significant probability of loss at the time of review to loans that indicate a probability that the entire balance of the loan will be uncollectible.  If at the time of review we determine it is probable that we will not collect the principal and interest cash flows contractually due on the loan, estimates of future expected cash flows or appraisals of the

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collateral securing the debt are used to determine the necessary allowances.  The internal loan review department maintains a list of all loans or loan relationships that are graded as having more than the normal degree of risk associated with them. In addition, a list of specifically reserved loans or loan relationships of $150,000 or more is updated on a quarterly basis in order to properly determine necessary allowances and keep management informed on the status of attempts to correct the deficiencies noted with respect to the loan.
We calculate historical loss ratios for pools of loans with similar characteristics based on the proportion of actual charge-offs experienced, consistent with the characteristics of remaining loans, to the total population of loans in the pool. The historical gross loss ratios are updated based on actual charge-off experience quarterly and adjusted for qualitative factors. All loans are subject to individual analysis if determined to be impaired with the exception of consumer loans and loans secured by 1-4 family residential loans.
Industry and our own experience indicates that a portion of our loans will become delinquent and a portion of the loans will require partial or full charge-off.  Regardless of the underwriting criteria utilized, losses may occur as a result of various factors beyond our control, including, among other things, changes in market conditions affecting the value of properties used as collateral for loans and problems affecting the credit worthiness of the borrower and the ability of the borrower to make payments on the loan.  Our determination of the appropriateness of the allowance for loan losses is based on various considerations, including an analysis of the risk characteristics of various classifications of loans, previous loan loss experience, specific loans which would have loan loss potential, delinquency trends, estimated fair value of the underlying collateral, current economic conditions, and geographic and industry loan concentration.
After all of the data in the loan portfolio is accumulated, the reserve allocations are separated into various loan classes.
As of March 31, 2017 , our review of the loan portfolio indicated that a loan loss allowance of $18.5 million was appropriate to cover probable losses in the portfolio.  Changes in economic and other conditions may require future adjustments to the allowance for loan losses.
During the three months ended March 31, 2017 , the allowance for loan losses increase d $574,000 , or 3.2% , to $18.5 million , or 0.73% of total loans, when compared to $17.9 million , or 0.70% of total loans at December 31, 2016 , due primarily to changes in qualitative factors in accordance with our methodology for determining the estimate of the allowance for loan loss. The allowance for loan losses decreased $3.3 million , or 15.2% , from $21.8 million , or 0.89% of total loans at March 31, 2016 as a result of charge-offs in the second half of 2016 associated with two large commercial borrowing relationships, one of which previously had a specific reserve.
For the three months ended March 31, 2017 , loan charge-offs were $1.1 million and recoveries were $0.5 million . For the three months ended March 31, 2016 , loan charge-offs were $1.1 million and recoveries were $0.9 million. The necessary provision expense was estimated at $1.1 million for the three months ended March 31, 2017 , a decrease of $1.2 million , or 52.6% , for the comparable period in 2016 .
Nonperforming Assets
Nonperforming assets consist of delinquent loans 90 days or more past due, nonaccrual loans, OREO, repossessed assets and restructured loans.  Nonaccrual loans are loans 90 days or more delinquent and collection in full of both the principal and interest is not expected.  Additionally, some loans that are not delinquent may be placed on nonaccrual status due to doubts about full collection of principal or interest.  When a loan is categorized as nonaccrual, the accrual of interest is discontinued and any accrued balance is reversed for financial statement purposes. OREO represents real estate taken in full or partial satisfaction of debts previously contracted.  The dollar amount of OREO is based on a current evaluation of the OREO at the time it is recorded on our books, net of estimated selling costs.  Updated valuations are obtained as needed and any additional impairments are recognized.  Restructured loans represent loans that have been renegotiated to provide a below market or deferral of interest or principal because of deterioration in the financial position of the borrowers.  The restructuring of a loan is considered a “troubled debt restructuring” if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession.  Concessions may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules and other actions intended to minimize potential losses.  Categorization of a loan as nonperforming is not in itself a reliable indicator of potential loan loss.  Other factors, such as the value of collateral securing the loan and the financial condition of the borrower must be considered in judgments as to potential loan loss.  

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The following tables set forth nonperforming assets for the periods presented (in thousands):
 
At
March 31,
2017
 
At
December 31,
2016
 
At
March 31,
2016
Nonaccrual loans
$
7,261

 
$
8,280

 
$
21,927

Accruing loans past due more than 90 days
1

 
6

 
7

Restructured loans
6,424

 
6,431

 
11,762

Other real estate owned
367

 
339

 
265

Repossessed assets
26

 
49

 
85

Total Nonperforming Assets
$
14,079

 
$
15,105

 
$
34,046

 
At
March 31,
2017
 
At
December 31,
2016
 
At
March 31,
2016
Asset Quality Ratios:
 
 
 
 
 
Nonaccruing loans to total loans
0.29
%
 
0.32
%
 
0.90
%
Allowance for loan losses to nonaccruing loans
254.58

 
216.32

 
99.42

Allowance for loan losses to nonperforming assets
131.29

 
118.58

 
64.03

Allowance for loan losses to total loans
0.73

 
0.70

 
0.89

Nonperforming assets to total assets
0.25

 
0.27

 
0.68

Net charge-offs to average loans
0.08

 
0.02

 
0.04

Total nonperforming assets at March 31, 2017 were $14.1 million , a decrease of $1.0 million , or 6.8% , from $15.1 million at December 31, 2016 and a decrease of $20.0 million , or 58.6% , from $34.0 million at March 31, 2016 .  
From December 31, 2016 to March 31, 2017 , nonaccrual loans decrease d $1.0 million , or 12.3% , to $7.3 million , and decrease d $14.7 million , or 66.9% , from March 31, 2016 .  Of the total nonaccrual loans at March 31, 2017 , $5.1 million are commercial loans, $723,000 are commercial real estate loans, $673,000 are 1-4 family residential real estate loans, $683,000 are loans to individuals, and $55,000 are construction loans. Restructured loans totaled $6.4 million at March 31, 2017 , with a slight decrease of $7,000 , or 0.1% , compared to December 31, 2016 and decrease d $5.3 million , or 45.4% , when compared to $11.8 million at March 31, 2016 . OREO increase d $28,000 , or 8.3% , to $367,000 at March 31, 2017 from $339,000 at December 31, 2016 and increase d $102,000 , or 38.5% , from $265,000 at March 31, 2016 .  The OREO at March 31, 2017 consisted primarily of commercial real estate and 1-4 family residential properties.  We are actively marketing all properties and none are being held for investment purposes.  Repossessed assets decrease d $23,000 , or 46.9% , to $26,000 at March 31, 2017 , from $49,000 at December 31, 2016 and decrease d $59,000 , or 69.4% , from $85,000 at March 31, 2016 .
Recent Accounting Pronouncements
See “Note 1 – Summary of Significant Accounting and Reporting Policies” in our consolidated financial statements included in this Quarterly Report on Form 10-Q.

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ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The disclosures set forth in this item are qualified by the section captioned “Forward-Looking Statements” included in “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this report and other cautionary statements set forth elsewhere in this Quarterly Report on Form 10-Q.
Refer to the discussion of market risks included in “Item 7A.  Quantitative and Qualitative Disclosures About Market Risks” in our Annual Report on Form 10-K for the year ended December 31, 2016 .  There have been no significant changes in the types of market risks we face since December 31, 2016 .
In the banking industry, a major risk exposure is changing interest rates.  The primary objective of monitoring our interest rate sensitivity, or risk, is to provide management the tools necessary to manage the balance sheet to minimize adverse changes in net interest income as a result of changes in the direction and level of interest rates.  Federal Reserve Board monetary control efforts, the effects of deregulation, economic uncertainty and legislative changes have been significant factors affecting the task of managing interest rate sensitivity positions in recent years.
In an attempt to manage our exposure to changes in interest rates, management closely monitors our exposure to interest rate risk through our ALCO.  Our ALCO meets regularly and reviews our interest rate risk position and makes recommendations to our board for adjusting this position.  In addition, our board reviews our asset/liability position on a monthly basis.  We primarily use two methods for measuring and analyzing interest rate risk: net income simulation analysis and MVPE modeling.  We utilize the net income simulation model as the primary quantitative tool in measuring the amount of interest rate risk associated with changing market rates.  This model quantifies the effects of various interest rate scenarios on projected net interest income and net income over the next 12 months.  The model is used to measure the impact on net interest income relative to a base case scenario of rates immediately increasing 100 and 200 basis points or decreasing 100 and 200 basis points over the next 12 months.  These simulations incorporate assumptions regarding balance sheet growth and mix, pricing and the repricing and maturity characteristics of the existing and projected balance sheet.  The impact of interest rate-related risks such as prepayment, basis and option risk are also considered.  As of March 31, 2017 , the model simulations projected that immediate increases in interest rates of 100 and 200 basis points would result in positive variances in net interest income of 1.03% and 0.27%, respectively, relative to the base case over the next 12 months, while an immediate decrease in interest rates of 100 and 200 basis points would result in positive variances in net interest income of 3.28% and 1.53%, respectively, relative to the base case over the next 12 months. As of December 31, 2016 , the model simulations projected that an immediate increase in interest rates of 100 basis points would result in a positive variance on net interest income of 0.88% and an immediate increase in interest rates of 200 basis points would result in a negative variance on net interest income of 0.21%, relative to the base case over the next 12 months, while an immediate decrease in interest rates of 100 and 200 basis points would result in positive variances in net interest income of 2.25% and 1.67%, respectively, relative to the base case over the next 12 months.  As of March 31, 2016 , the model simulations projected that 100 and 200 basis point immediate increases in interest rates would result in positive variances on net interest income of 0.96% and 2.36%, respectively, relative to the base case over the next 12 months, while an immediate decrease in interest rates of 100 and 200 basis points would result in negative variances in net interest income of 1.98% and 2.16%, respectively, relative to the base case over the next 12 months.  As part of the overall assumptions, certain assets and liabilities are given reasonable floors.  This type of simulation analysis requires numerous assumptions including but not limited to changes in balance sheet mix, prepayment rates on mortgage-related assets and fixed rate loans, cash flows and repricing of all financial instruments, changes in volumes and pricing, future shapes of the yield curve, relationship of market interest rates to each other (basis risk), credit spread and deposit sensitivity.  Assumptions are based on management’s best estimates but may not accurately reflect actual results under certain changes in interest rates.
The ALCO monitors various liquidity ratios to ensure a satisfactory liquidity position for us. Management continually evaluates the condition of the economy, the pattern of market interest rates and other economic data to determine the types of investments that should be made and at what maturities. Using this analysis, management from time to time assumes calculated interest sensitivity gap positions to maximize net interest income based upon anticipated movements in the general level of interest rates. Regulatory authorities also monitor our gap position along with other liquidity ratios. In addition, as described above, we utilize a simulation model to determine the impact of net interest income under several different interest rate scenarios. By utilizing this technology, we can determine changes that need to be made to the asset and liability mixes to mitigate the change in net interest income under these various interest rate scenarios.

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ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Management, including our Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”), undertook an evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report, and, based on that evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report, in recording, processing, summarizing and reporting in a timely manner the information that the Company is required to disclose in its reports under the Exchange Act and in accumulating and communicating to the Company’s management, including the Company’s CEO and CFO, such information as appropriate to allow timely decisions regarding required disclosure.  
Changes in Internal Control Over Financial Reporting
No changes were made to our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended March 31, 2017 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1.     LEGAL PROCEEDINGS  

We are a party to various litigation in the normal course of business. Management, after consulting with our legal counsel, believes that any liability resulting from litigation will not have a material effect on our financial position, results of operations or liquidity.

ITEM 1A.     RISK FACTORS

Additional information regarding risk factors appears in “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Forward-Looking Statements” of this Form 10-Q and in Part I - “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2016 .  There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2016 . The risks and uncertainties described in our Annual Report on Form 10-K for the year ended December 31, 2016 are not the only ones we face. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations.

ITEM 2.     UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.

ITEM 3.     DEFAULTS UPON SENIOR SECURITIES
None.

ITEM 4.     MINE SAFETY DISCLOSURES
None.

ITEM 5.     OTHER INFORMATION
None.

ITEM 6.     EXHIBITS
A list of exhibits to this Form 10-Q is set forth on the Exhibit Index and is incorporated herein by reference.

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Table of Contents




SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
 
SOUTHSIDE BANCSHARES, INC.
 
 
 
DATE:
April 28, 2017
BY:
/s/ Lee R. Gibson
 
 
 
Lee R. Gibson, CPA
 
 
 
President and Chief Executive Officer
 
 
 
(Principal Executive Officer)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
DATE:
April 28, 2017
BY:
 /s/  Julie N. Shamburger
 
 
 
Julie N. Shamburger, CPA
 
 
 
Executive Vice President and Chief Financial Officer
 
 
 
(Principal Financial Officer)
 


57
Table of Contents


Exhibit Index

 
 
 
 
 
 
Incorporated by Reference
Exhibit Number
 
Exhibit Description
 
Filed Herewith
 
Exhibit
 
Form
 
Filing Date
 
File No.
(3)
 
Articles of Incorporation and Bylaws
 
 
 
 
 
 
 
 
 
 
3.1
 
 
 
 
3 (a)
 
10-Q
 
5/9/2014
 
0-12247
 
 
 
 
 
 
 
 
 
 
 
 
 
3.2
 
 
 
 
   3 (b)(i)
 
8-K
 
11/24/2014
 
0-12247
 
 
 
 
 
 
 
 
 
 
 
 
 
(10)
 
Material Contracts
 
 
 
 
 
 
 
 
 
 
10.1
 
Employment Agreement, Julie Shamburger
 
X
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
10.2
 
Deferred Compensation Agreement, Tim Alexander
 
X
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
10.3
 
Deferred Compensation Agreement, Julie Shamburger
 
X
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(31)
 
Rule 13a-14(a)/15d-14(a) Certifications
 
 
 
 
 
 
 
 
 
 
31.1
 
Certification of Chief Executive Officer
 
X
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
31.2
 
Certification of Chief Financial Officer
 
X
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(32)
 
Section 1350 Certification
 
 
 
 
 
 
 
 
 
 
†32
 
Certification of Executive Officer and Chief Financial Officer
 
X
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(101)
 
Interactive Date File
 
 
 
 
 
 
 
 
 
 
101.INS
 
XBRL Instance Document.
 
X
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
101.SCH
 
XBRL Taxonomy Extension Schema Document.
 
X
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document.
 
X
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document.
 
X
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document.
 
X
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document.
 
X
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
† The certification attached as Exhibit 32 accompanies this Quarterly Report on Form 10-Q and is “furnished” to the Commission pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed “filed” by us for purposes of Section 18 of the Securities Exchange Act of 1934, as amended.

58


EMPLOYMENT AGREEMENT

THIS EMPLOYMENT AGREEMENT is made this 4th day of June, 2008 (“Effective Date”), by and between Southside Bank ("the Company”), and Julie Shamburger (the “Employee”).

INTRODUCTION

The Board of Directors of the Company (the “Board”) has determined that it is in the best interests of the Company to retain the Employee’s services and to reinforce and encourage the continued attention and dedication of the Employee to her assigned duties.

AGREEMENT

WHEREAS, during her employment, Employee will establish and maintain relations and contacts with the clients, employees, and suppliers of the Company, all of which constitute valuable goodwill of the Company's business; and

WHEREAS, during her employment, Employee will learn and will have access to important Confidential Information and Trade Secrets (as defined herein) related to the Company's business; and

WHEREAS, Employee and the Company desire to enter into this Agreement in order to memorialize the terms and conditions of Employee's employment.

NOW, THEREFORE, in consideration of Employee's employment with the Company, a wholly owned subsidiary of Southside Bancshares, Inc. (“SBSI”) and in consideration of the additional promises and the mutual covenants herein contained, the Company and the Employee hereby agree as follows:

1.     Employment . Upon the terms and subject to the conditions contained in this Agreement, the Employee is hereby deemed to be employed under the terms of this Agreement on the Effective Date as an Executive Vice President of the Company. The Employee agrees to provide full-time services for the Company during the term of this Agreement. The Employee agrees to devote her best efforts to the business of the Company, and shall perform her duties in a diligent, trustworthy, and business-like manner, all for the purpose of advancing the business of the Company. Notwithstanding the above, the Employee may engage in other business interests or investments which do not conflict with the interests of Company or materially prevent the Employee from performing her contemplated services hereunder on behalf of the Company.

2.     Duties . In her capacity as an Executive Vice President of the Company, the Employee shall have such responsibilities and shall render such services as shall be assigned to her from time to time by the Chief Executive Officer of the Company, which shall be consistent with the responsibilities of similarly situated executives of comparable companies in similar lines of business. The Employee’s duties may, from time to time, be changed or modified at the discretion of the Chief Executive Officer.

3.     Employment Term . Unless earlier terminated in accordance with Section 5 hereof, the Employee’s employment shall be for a two (2) year term (the “Initial Term”), beginning on the Effective Date. Beginning on the first anniversary of the Effective Date and on each anniversary of the Effective Date thereafter, Employee's employment with Company shall, without further action by the Employee or the Company, be extended by an additional one-year period (with any such extended period being referred to as the "Extended Term"); provided , however , that either party may cause Employee's employment to cease to extend automatically by giving written notice to the other party not less than ninety (90) days prior to the next annual anniversary of the Effective Date. Upon such notice, Employee's employment shall terminate upon the expiration of the Initial Term or the then-current Extended Term, including any prior extensions. If Company elects to terminate the automatic extension, Section 9 shall no longer be applied following termination of employment. For purposes of this Agreement, the entire period of Employee's employment shall be referred to as the "Employment Period."

4.     Compensation and Benefits .

(a)     Base Salary . As of the Effective Date of this Agreement, the Company agrees to pay the Employee during the term of this Agreement an initial base salary of $120,000.00 per year (the "Base Salary"), payable in accordance with Company’s normal payroll practices with such payroll deductions and withholdings as are required by law or are otherwise authorized by Employee. The Employee’s Base Salary shall be reviewed no less frequently than annually by the Compensation Committee of the Board of Directors of SBSI (the “Compensation Committee”). During the term of

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this Agreement, it is agreed that Company may not reduce Employee’s Base Salary in any calendar year by an amount in excess of five (5%) percent of the Base Salary unless such reduction is part of a general reduction in compensation among employees of the same or similar category.

(b)     Annual Incentive Payment . In addition to other compensation to be paid under this Section 4, each year during the Employment Period the Employee shall be eligible to receive an annual incentive payment (the “Annual Incentive Payment”), which shall not be less than 12.5% of Base Salary. The amount actually awarded and paid to the Employee each year will be determined by the Compensation Committee and may be based on specific performance criteria to be identified under a separate communication. Any payments made under this section shall be paid no later than March 15 of the following calendar year.

(c)     Incentive, Savings and Retirement Plans . During the Employment Period, the Employee shall be entitled to participate in all incentive, savings and retirement plans, practices, policies and programs made available by the Company to officers of comparative level with Employee (the "Peer Executives").

(d)     Welfare Benefit Plans . During the Employment Period, the Employee and the Employee’s eligible dependents shall be eligible for participation in, and shall receive all benefits under, the welfare benefit plans, practices, policies and programs provided by the Company (including, without limitation, medical, prescription, dental, disability, employee life, group life, accidental death and travel accident insurance plans and programs) (“Welfare Plans”) to the extent applicable generally to Peer Executives.

(e)     Fringe Benefits . During the Employment Period, to the extent approved by the Board of Directors, the Employee shall be entitled to fringe benefits in accordance with the plans, practices, programs and policies of the Company on the same basis as other Peer Executives.

(f)     Vacation . During the Employment Period, the Employee will be entitled to such period of paid vacation as may be provided under any plans, practices, programs and policies of the Company available to other Peer Executives; provided , however , that Employee shall be entitled to a minimum of four (4) weeks paid vacation.

(g)     Reimbursement of Expenses . During the Employment Period, the Company shall reimburse the Employee in accordance with Company’s expense reimbursement policies for all reasonable, ordinary and necessary business expenses incurred by the Employee in the course of her duties conducted on behalf of the Company. In addition, the Company may pay the Employee’s annual dues at a local country club, and expenses related to the Employee’s use of such country club for matters related to the business of the Company. The Company shall also reimburse Employee’s reasonable expenses for continuing education courses necessary to maintain any certifications or licenses Employee may hold.

5.     Termination of Employment. The Employee’s employment may be terminated at any time by either party for the reasons set forth in this Section 5.

(a)     Termination by the Employee . Employee may terminate her employment during the Employment Period for Good Reason (but only in the event of a Change in Control, as defined in Section 7 hereof), or for no reason. For the purpose of this Agreement, “Good Reason” shall mean:

(i)    Without the Employee’s express written consent, the assignment to the Employee of any duties or responsibilities inconsistent in any material respect with the Employee’s position (including status, offices, titles and reporting relationships), authority, duties or responsibilities as in effect of the Effective Date, or any other action by the Company which results in a diminution in such position, authority, duties or responsibilities, excluding for this purpose an isolated, insubstantial and inadvertent action not taken in bad faith and which is remedied by the Company promptly after receipt of notice thereof given by the Employee;

(ii)    A reduction by the Company in the Employee’s Base Salary;

(iii)    The failure by the Company (a) to continue in effect any compensation plan in which the Employee participates as of the Effective Date that is material to the Employee’s total compensation, unless an equitable arrangement (embodied in an ongoing substitute or alternative plan) has been made with respect to such plan, or (b) to continue the Employee’s participation therein (or in such substitute or alternative plan) on a basis not materially less favorable, both in terms of the amount of benefits provided and the level of the Employee’s participation relative to other participants;

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(iv)    Any failure of the Company to obtain the assumption of, or the agreement to perform, this Agreement by any successor as contemplated in Section 13(b) hereof;

(v)    The material breach by the Company of any other provision of this Agreement; or

(vi)    The Company requiring the Employee to be based anywhere other than Smith County, or, in the event the Employee consents to any relocation, the failure by the Company to pay (or to reimburse the Employee) for all reasonable moving expenses incurred by the Employee relating to a change of the Employee’s principal residence in connection with such relocation and to indemnify the Employee against any loss realized on the sale of the Employee’s principal residence in connection with any such change of residence.

Good Reason shall not include the Employee’s death or Disability or Retirement; provided that the Employee’s mental or physical incapacity following the occurrence of an event described in clause (i) - (vi) above shall not affect the Employee’s ability to terminate for Good Reason. The Employee’s continued employment shall not constitute consent to, or a waiver of rights with respect to, any circumstance constituting Good Reason hereunder. Any good faith determination of Good Reason made by the Employee shall be deemed prima facie evidence that qualifies for termination for Good Reason but such determination by the Employee may be contested and disputed by the Company. The Company shall have an opportunity to cure any claimed event of Good Reason within 30 days of receiving written notice from the Employee and the Board’s good faith determination of cure shall be binding. The Company shall notify the Employee of the timely cure of any claimed event of Good Reason and the manner in which such cure was effected, and any Notice of Termination delivered by the Employee based on such claimed Good Reason shall be deemed withdrawn and shall not be effective to terminate the Agreement.

(b)     Termination by the Company . The Company may terminate the Employee’s employment during the Employment Period with or without Cause. For purposes of this Agreement, “Cause” shall mean:

(i) Employee’s material failure to perform Employee’s duties with the Company (other than any such failure resulting from incapacity due to physical or mental illness), after a written demand for performance is delivered to Employee by the Company which specifically identifies the manner in which the Company believes that Employee has intentionally and materially failed to perform Employee’s duties; or

(ii) Employee’s engaging in any illegal conduct or misconduct that is materially and demonstrably injurious to the Company, its financial condition, or its reputation; or

(iii) Employee’s engaging in any act or omission that constitutes, on the part of the Employee, fraud, theft, misappropriation, embezzlement, breach of fiduciary duty or dishonesty; or

(iv) Entry of an order by any state or federal regulatory agency either removing Employee from Employee’s position with the Company or its affiliates or prohibiting Employee from participating in the conduct of the affairs of the Company; or

(v) Employee’s failure to cure a material breach of any provision of this Agreement after a written demand for cure is delivered to Employee by the Company .

Termination for Cause shall only occur after the Board, in its sole and absolute discretion, has made a full and thorough determination of “Cause.”

Additionally, Employee's employment may be terminated by Company as a result of a Change in Control, as defined in Section 7 hereof. Such a termination of employment shall be treated the same as a termination without Cause for purposes of Section 6 of this Agreement.
    
(c)     Death, Retirement or Disability . The Employee’s employment shall terminate automatically upon the death or Retirement of the Employee during the Employment Period. For purposes of this Agreement, “Retirement” shall mean normal retirement as defined in the Company’s then-current retirement plan, or if there is no such retirement plan, “Retirement” shall mean voluntary termination after attaining age 65. If the Company determines in good faith that the Disability of the Employee has occurred during the Employment Period (pursuant to the definition of Disability

3


set forth below), it may give to the Employee written notice of its intention to terminate the Employee’s employment. In such event, the Employee’s employment with the Company shall terminate effective on the 30th day after receipt of such written notice by the Employee (the “Disability Effective Date”), provided that, within the 30 days after such receipt, the Employee shall not have returned to full-time performance of the Employee’s duties. For purposes of this Agreement, “Disability” shall mean the inability of the Employee, as determined by the Board, to perform the essential functions of her regular duties and responsibilities, with or without reasonable accommodation, due to a medically determinable physical or mental illness which has lasted (or can reasonably be expected to last) for a period of six (6) consecutive months.

(d)     Notice of Termination . Any termination by the Company for Cause, or by the Employee for Good Reason in the event of a Change in Control, shall be communicated by Notice of Termination to the other party hereto given in accordance with Section 13(d) of this Agreement. For purposes of this Agreement, a "Notice of Termination" means a written notice which (i) indicates the specific termination provision in this Agreement relied upon, (ii) to the extent applicable, sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Employee's employment under the provision so indicated and (iii) specifies the termination date. The failure by the Employee or the Company to set forth in the Notice of Termination any fact or circumstance which contributes to a showing of Good Reason or Cause shall not waive any right of the Employee or the Company, respectively, hereunder or preclude the Employee or the Company, respectively, from asserting such fact or circumstance in enforcing the Employee's or the Company's rights hereunder.

(e)     Date of Termination . "Date of Termination" means (i) if the Employee's employment is terminated by the Company for Cause, or by the Employee for Good Reason in the event of a Change in Control, the date of termination as specified in the Notice of Termination, (ii) if the Employee's employment is terminated by the Company other than for Cause, the Date of Termination shall be either the date on which the Company notifies the Employee of such termination or a date otherwise specified by the Company, (iii) if the Employee's employment is terminated by reason of death, Retirement or Disability, the Date of Termination shall be the date of the death or Retirement of the Employee or the Disability Effective Date, as the case may be, and (iv) if the Employee's employment is terminated by the Employee without Good Reason in the event of a Change in Control, the Date of Termination shall be at least two (2) weeks from the date that the Employee notifies the Company of her resignation (during which two (2) week period Employee may be required, in the discretion of Company, to continue to perform services on behalf of Company).

6.     Obligations of the Company upon Termination .

(a)     Termination by Employee except for Good Reason in the event of a Change in Control; Termination by Company with Cause . If, during the Employment Period, the Employee terminates her employment without Good Reason or the Company terminates Employee's employment with Cause, Employee shall be entitled to receive her accrued but unpaid Base Salary up to and including the Date of Termination as well as all previously vested benefits. Employee shall not be entitled to receive any additional compensation or benefits from Company.

(b)     Termination by the Company without Cause; Termination by Employee for Good Reason in the event of a Change in Control . If, during the Employment Period, the Company terminates the Employee’s employment without Cause (excluding termination for death, Retirement or Disability) or as a result of a Change in Control (as defined in Section 7 of this Agreement), or the Employee terminates her employment for Good Reason in the event of a Change in Control, and in any case only provided that Employee executes a release in a form mutually acceptable to the parties (the “Release”), then the following shall occur:

(i)    the Company shall provide to the Employee in a single lump sum cash payment within 30 days after the Date of Termination, or if later, within five days after the Release becomes effective and nonrevocable, the aggregate of the following amounts, to the extent not previously paid to the Employee:

(a) the Employee’s accrued but unpaid Base Salary through the Date of Termination;
(b) a pro-rata bonus for the year in which the Date of Termination occurs, computed as the product of (x) the Employee’s Target Bonus (as defined by Company policy) for such year and (y) a fraction, the numerator of which is the number of days in the current fiscal year through the Date of Termination, and the denominator of which is 365;
(c) any accrued pay in lieu of unused vacation (in accordance with the Company’s vacation policy);

4


(d) unless the Employee has a later payout date that is required in connection with the terms of a deferral plan or agreement, any vested compensation previously deferred by the Employee (together with any amount equivalent to accrued interest or earnings thereon); and
(e) a severance payment equal to the monthly salary for the remainder of the Initial Term or the then-current Extended Term, whichever is applicable, plus the sum of ten thousand dollars ($10,000).
Provided , however , that in lieu of Section 6(b)(i)(e), the severance payment in the event of a Change of Control shall be calculated pursuant to clause (x) or (y) below, as applicable:
(x)    if the Date of Termination occurs more than six (6) months prior to the closing of a pending event that results in a Change of Control or more than two (2) years after the occurrence of a Change of Control, the severance payment shall be the product of two times the sum of (1) the Employee’s Base Salary in effect as of the Date of Termination (ignoring any decrease in the Employee’s Base Salary unless consented to by the Employee), and (2) the greater of the average of the annual bonuses earned by the Employee for the two fiscal years in which annual bonuses were paid immediately preceding the year in which the Date of Termination occurs, or the Employee’s Target Bonus for the year in which the Date of Termination occurs; or
(y)    if the Date of Termination occurs within six months prior or within two years after the occurrence of a Change of Control, the severance payment shall be the product of two times the sum of (1) the Employee’s Base Salary in effect as of the Date of Termination, and (2) the greater of the average of the annual bonuses earned by the Employee for the two fiscal years in which annual bonuses were paid immediately preceding the year in which the Date of Termination occurs, or the Employee’s Target Bonus for the year in which the Date of Termination occurs.
(ii)    all grants of stock options and other equity awards granted by the Company or the SBSI Compensation Committee, and held by the Employee as of the Date of Termination will become immediately vested and exercisable as of the Date of Termination and, to the extent necessary, this Agreement is hereby deemed an amendment of any such outstanding stock option or other equity award; and

(iii)    to the extent not theretofore paid or provided, the Company shall timely pay or provide to the Employee any other amounts or benefits required to be paid or provided or which the Employee is eligible to receive under any plan, program, policy or practice of the Company to the extent provided to Peer Executives prior to the Date of Termination (such other amounts and benefits shall be hereinafter referred to as the “Other Benefits”).

(c)     Death . If the Employee’s employment is terminated by reason of Employee’s death during the Employment Period, then this Agreement will terminate without further obligations to Employee, other than for payment to Employee's estate or beneficiaries of Employee's accrued but unpaid Base Salary up to and including the Date of Termination as well as Other Benefits. Employee's estate or beneficiaries shall not be entitled to receive any additional compensation or benefits from Company. With respect to the provision of Other Benefits, the term Other Benefits as used in this Section 6(c) shall include, without limitation, and Employee's estate or beneficiaries shall be entitled after the Date of Termination to receive, death and other benefits under such plans, programs, practices and policies relating to death, if any, as are applicable to Employee on the Date of Termination.

(d)     Retirement . If Employee’s employment is terminated by reason of Employee’s Retirement during the Employment Period, this Agreement shall terminate without further obligations to Employee, other than for payment of accrued but unpaid Base Salary up to and including the Date of Termination and the timely payment or provision of Other Benefits. With respect to the provision of Other Benefits, the term Other Benefits as used in this Section 6(d) shall include, without limitation, and Employee shall be entitled after the Date of Termination to receive, retirement and other benefits under such plans, programs, practices and policies relating to retirement, if any, as are applicable to Employee on the Date of Termination.

(e)     Disability . If the Employee’s employment is terminated by reason of Employee’s Disability during the Employment Period, then this Agreement will terminate without further obligations to Employee, other than for payment

5


of Employee's accrued but unpaid Base Salary up to and including the Date of Termination as well as Other Benefits. Employee shall not be entitled to receive any additional compensation or benefits from Company. With respect to the provision of Other Benefits, the term Other Benefits as used in this Section 6(e) shall include, without limitation, and Employee shall be entitled after the Date of Termination to receive, disability and other benefits under such plans, programs, practices and policies relating to disability, if any, as are applicable to Employee on the Date of Termination.

(f)     Expiration of Employment Period . If the Employee’s employment shall be terminated due to the expiration of the Employment Period as provided for in Section 3, this Agreement shall terminate without further obligations to the Employee, other than for payment of Employee's accrued but unpaid Base Salary up to and including the Date of Termination and the timely payment or provision of Other Benefits. Employee shall not be entitled to receive any additional compensation or benefits from Company.

(g)     Internal Revenue Code Section 280G .

(i) Anything in this Agreement to the contrary notwithstanding, in the event it shall be determined that any payment or distribution by the Company to or for the benefit of the Employee (whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise) (a "Payment" would be subject to the excise tax imposed by Section 4999 of the Code (the "Excise Tax"), then, prior to the making of any Payment to the Employee, a calculation shall be made comparing (i) the net benefit to the Employee of the Payment after payment of the Excise Tax, to (ii) the net benefit to the Employee if the Payment had been limited to the extent necessary to avoid being subject to the Excise Tax. If the amount calculated under (i) above is less than the amount calculated under (ii) above, then the Payment shall be limited to the extent necessary to avoid being subject to the Excise Tax (the “Reduced Amount”). In that event, the Employee shall direct which Payments are to be modified or reduced.

(ii) Unless otherwise agreed upon by the Company and the Employee, all determinations required to be made under this Section 6(g), including the assumptions to be used in arriving at such determination, shall be made by an independent accounting firm mutually acceptable to the Company and the Employee (the "Accounting Firm") which shall provide detailed supporting calculations both to the Company and the Employee within 15 business days of the receipt of notice from the Employee that there has been a Payment, or such earlier time as is requested by the Company. All fees and expenses of the Accounting Firm shall be borne solely by the Company. Any determination by the Accounting Firm shall be binding upon the Company and the Executive

(h)     Limitation of Benefits . Notwithstanding any other provision of this Agreement, nothing shall obligate the Company to make any payment to the Employee that is prohibited by the provisions of 12 U.S.C. § 1828(k) or the implementing regulations of the FDIC; provided, however, the Company shall exercise commercially reasonable efforts to obtain the approval of the Board of Governors of the Federal Reserve System, and the concurrence of the FDIC, to make the payments provided herein (or, to the extent that they will not approve payment in full, such lesser portion as shall be acceptable to them).

7.     Change in Control . For purposes of this Agreement, “Change in Control” shall mean the occurrence of any one of the following: a Change in the Actual Control of the Company or SBSI as described in Section 7(i), a Change in Effective Control, as described in Section 7(ii), and a Change in the Ownership of the Company’s or SBSI's Assets, as described in Section 7(iii).

(i)    Change in Actual Control shall mean the acquisition by any one person, or more than one person acting as a group (as defined in subsection (iv), below) of ownership of stock of the Company or SBSI that, together with stock held by such person or group, constitutes more than 50 percent of the total fair market value or total voting power of the stock of the Company or SBSI, respectively. However, if any one person, or more than one person acting as a group, is considered to own more than 50 percent of the total fair market value or total voting power of the stock of the Company or SBSI, the acquisition of additional stock by the same person or persons is not considered to cause a change in the ownership of the Company or SBSI, respectively, or to cause a Change in the Effective Control (within the meaning of Section 7(a)(ii)) of the Company or SBSI, respectively. An increase in the percentage of stock owned by any one person, or persons acting as a group, as a result of a transaction in which the Company or SBSI acquires its stock in exchange for property will be treated as an acquisition of stock for purposes of this section. Notwithstanding the foregoing, the acquisition of the common stock of SBSI by any direct or indirect subsidiary or affiliate of the Company shall not be considered to cause a Change in Control.


6


(ii)    Change in Effective Control shall mean: (A) the acquisition by any one person, or more than one person acting as a group (as defined in Section (iv), below), during any 12-month period of stock of the Company or SBSI possessing 35 percent or more of the total voting power of the stock of the Company or SBSI, respectively; or (B) the replacement, of a majority of members of the Company’s board of directors during any 12-month period by directors whose appointment or election is not endorsed by a majority of the members of the Company’s board of directors prior to the date of election in accordance with Treasury Regulation § 1.409A-1(g)(5)(iv)(A)(2). Notwithstanding the foregoing, (x) if any one person, or more than one person acting as a group, is considered to effectively control the Company or SBSI (within the meaning of this subsection (ii)), the acquisition of additional control of the Company or SBSI, respectively, by the same person or persons is not considered to cause a Change in Control and (y) the acquisition of the common stock of SBSI by any direct or indirect subsidiary or affiliate of the Company shall not be considered to cause a Change in Control.

(iii)    Change in the Ownership of the Company’s or SBSI's Assets shall mean the acquisition by any one person, or more than one person acting as a group (as defined in subsection (iv), below), during any 12-month period of assets from the Company or SBSI that have a total gross fair market value equal to or more than 40 percent of the total gross fair market value of all of the assets of the Company or SBSI, respectively, immediately prior to such acquisition or acquisitions.  Notwithstanding the foregoing, there is no change in control event under this section when there is a transfer to an entity that is controlled by the Company or the shareholders of the Company immediately after the transfer.

(iv)    Persons acting as a group. For purposes of this Section 7, persons will not be considered to be acting as a group solely because they purchase or own stock of the same corporation at the same time, or as a result of the same public offering. However, persons will be considered to be acting as a group if they are owners of a corporation that enters into a merger, consolidation, purchase or acquisition of stock, or similar business transaction with the corporation. If a person, including an entity, owns stock in both corporations that enter into a merger, consolidation, purchase or acquisition of stock, or similar transaction, such shareholder is considered to be acting as a group with other shareholders in a corporation prior to the transaction giving rise to the change and not with respect to the ownership interest in the other corporation.

8.     Delivery of Documents upon Termination . The Employee shall deliver to the Company or its designee at the termination of the Employee’s employment all correspondence, memoranda, notes, records, drawings, sketches, plans, customer lists, product compositions, and other documents and all copies thereof, made, composed or received by the Employee, solely or jointly with others, that are in the Employee’s possession, custody, or control at termination and that are related in any manner to the past, present, or anticipated business or any member of the Company.

9.     Restrictions on Conduct .

(a)     General . Employee and the Company understand and agree that the purpose of the provisions of this Section 9 is to protect the legitimate business interests of the Company, as more fully described below, and is not intended to eliminate Employee’s post-employment competition with the Company per se , nor is it intended to impair or infringe upon Employee’s right to work, earn a living, or acquire and possess property from the fruits of her labor. Employee hereby acknowledges that Employee has received good and valuable consideration for the post-employment restrictions set forth in this Section 9 in the form of her employment and the compensation and benefits provided for herein. Employee hereby further acknowledges that the post-employment restrictions set forth in this Section 9 are reasonable and that they do not, and will not, unduly impair her ability to earn a living after the termination of this Agreement.

In addition, the parties acknowledge: (A) that Employee’s services under this Agreement require special expertise and talent in the provision of Competitive Services (as defined herein) and that Employee will have substantial contacts with customers, suppliers, advertisers, vendors and employees of the Company; (B) that pursuant to this Agreement, Employee will be placed in a position of trust and responsibility and she will have access to a substantial amount of Confidential Information and Trade Secrets (as defined herein) and that the Company is placing her in such position and giving her access to such information in reliance upon her agreement not to compete with the Company during the Restricted Period (as defined herein); (C) that due to her management duties, Employee will be the repository of a substantial portion of the goodwill of the Company and would have an unfair advantage in competing with the Company for business from its customers; (D) that due to Employee’s special experience and talent, the loss of Employee’s services to the Company under this Agreement cannot reasonably or adequately be compensated solely by damages in an action at law; (E) that Employee is capable of competing with the Company; and (F) that Employee is capable of obtaining gainful, lucrative and desirable employment that does not violate the restrictions contained in this Agreement.

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Therefore, subject to the limitations of reasonableness imposed by law, Employee shall be subject to the restrictions set forth in this Section 9.

(b)     Definitions .    
“Competitive Services” means chief accounting officer.

“ Confidential Information ” means all information regarding the Company, its activities, business or clients that is the subject of reasonable efforts by the Company to maintain its confidentiality and that is not generally disclosed by practice or authority to persons not employed by the Company, but that does not rise to the level of a Trade Secret. “Confidential Information” shall include, but is not limited to, financial plans and data concerning the Company; management planning information; business plans; operational methods; market studies; marketing plans or strategies; product development techniques or plans; customer lists; details of customer contracts; current and anticipated customer requirements; past, current and planned research and development; business acquisition plans; and new personnel acquisition plans. “Confidential Information” shall not include information that has become generally available to the public by the act of one who has the right to disclose such information without violating any right or privilege of the Company. This definition shall not limit any definition of “confidential information” or any equivalent term under state or federal law.

“ Person ” means any individual or any corporation, partnership, joint venture, limited liability company, association or other entity or enterprise.

“ Principal or Representative ” means a principal, owner, partner, shareholder, joint venturer, investor, member, trustee, director, officer, manager, employee, agent, representative or consultant.

“ Protected Customers ” means any Person to whom the Company sold its products or services or solicited to sell its products or services during the Employment Period.

“ Protected Employees ” means employees of the Company who were employed by the Company at any time during the Employment Period.

“ Restricted Period ” means the Employment Period and a period extending six (6) months from the termination of Employee’s employment with the Company for any reason whatsoever.

" Restricted Territory " means Smith County, Texas.

“ Restrictive Covenants ” means the restrictive covenants contained in Section 9(c) hereof.

“ Trade Secret ” means all information, without regard to form, including, but not limited to, technical or nontechnical data, a formula, a pattern, a compilation, a program, a device, a method, a technique, a drawing, a process, financial data, financial plans, product plans, distribution lists or a list of actual or potential customers, advertisers or suppliers which is not commonly known by or available to the public and which information: (A) derives economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use; and (B) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy. Without limiting the foregoing, Trade Secret means any item of confidential information that constitutes a “trade secret(s)” under applicable common law or statutory law.

(c)     Restrictive Covenants .
(i)     Covenant Not to Compete . In consideration of the compensation and benefits being paid and to be paid by the Company to Employee hereunder, Employee hereby agrees that, during the Restricted Period, Employee will not, without prior written consent of the Company, directly or indirectly, sell or otherwise provide Competitive Services within the Restricted Territory on her own behalf or as a Principal or Representative of any other Person; provided , however , that the provisions of this Agreement shall not be deemed to prohibit the ownership by Employee of not more than five percent (5%) of any class of securities of any corporation having a class of securities registered pursuant to the Securities Exchange Act of 1934, as amended.
(ii)     Restriction on Disclosure and Use of Confidential Information and Trade Secrets . Employee understands and agrees that the Confidential Information and Trade Secrets constitute valuable assets of the

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Company and may not be converted to Employee’s own use. Accordingly, Employee hereby agrees that Employee shall not, directly or indirectly, at any time during the Restricted Period, reveal, divulge, or disclose to any Person not expressly authorized by the Company any Confidential Information, and Employee shall not, directly or indirectly, at any time during the Restricted Period, use or make use of any Confidential Information in connection with any business activity other than that of the Company. Throughout the term of this Agreement and at all times after the date that this Agreement terminates for any reason, Employee shall not directly or indirectly transmit or disclose any Trade Secret of the Company to any Person, and shall not make use of any such Trade Secret, directly or indirectly, for herself or for others, without the prior written consent of the Company. The parties acknowledge and agree that this Agreement is not intended to, and does not, alter either the Company’s rights or Employee’s obligations under any applicable state or federal statutory or common law regarding trade secrets and unfair trade practices.

Anything herein to the contrary notwithstanding, Employee shall not be restricted from disclosing or using Confidential Information that is required to be disclosed by law, court order or other legal process; provided , however , that in the event disclosure is required by law, Employee shall provide the Company with prompt notice of such requirement so that the Company may seek an appropriate protective order prior to any such required disclosure by Employee.
(iii)     Nonsolicitation of Protected Employees . Employee understands and agrees that the relationship between the Company and each of its Protected Employees constitutes a valuable asset of the Company and may not be converted to Employee’s own use. Accordingly, Employee hereby agrees that during the Restricted Period, Employee shall not directly or indirectly, on Employee’s own behalf or as a Principal or Representative of any Person, solicit or induce any Protected Employee to terminate her or her employment relationship with the Company or to enter into employment with any other Person.
(iv)     Restriction on Relationships with Protected Customers . Employee understands and agrees that the relationship between the Company and each of its Protected Customers constitutes a valuable asset of the Company and may not be converted to Employee’s own use. Accordingly, Employee hereby agrees that, during the Restricted Period, Employee shall not, without the prior written consent of the Company, directly or indirectly, on Employee’s own behalf or as a Principal or Representative of any Person, solicit, divert, take away or attempt to solicit, divert or take away a Protected Customer; provided , however , that the prohibition of this covenant shall apply only to Protected Customers with whom Employee had Material Contact on the Company’s behalf during the Employment Period. For purposes of this Agreement, Employee had “Material Contact” with a Protected Customer if (a) she had business dealings with the Protected Customer on the Company’s behalf; (b) she was responsible for supervising or coordinating the dealings between the Company and the Protected Customer; or (c) she obtained Trade Secrets and/or Confidential Information about the customer as a result of her association with the Company.

(d)     Enforcement of Restrictive Covenants .

(i)     Rights and Remedies Upon Breach . In the event Employee breaches, or threatens to commit a breach of, any of the provisions of the Restrictive Covenants, the Company shall have the following rights and remedies, which shall be independent of any others and severally enforceable, and shall be in addition to, and not in lieu of, any other rights and remedies available to the Company at law or in equity:

(A)    the right and remedy to enjoin, preliminarily and permanently and without the necessity of posting bond, Employee from violating or threatening to violate the Restrictive Covenants and to have the Restrictive Covenants specifically enforced by any court of competent jurisdiction, it being agreed that any breach or threatened breach of the Restrictive Covenants would cause irreparable injury to the Company and that money damages would not provide an adequate remedy to the Company;

(B)    the right and remedy to require Employee to account for and pay over to the Company all compensation, profits, monies, accruals, increments or other benefits derived or received by Employee as the result of any transactions constituting a breach of the Restrictive Covenants; and

(C)    the right and remedy to require Employee to pay the reasonable attorneys’ fees incurred by Company in enforcing the Restrictive Covenants.


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(ii)     Severability of Covenants . Employee acknowledges and agrees that the Restrictive Covenants are reasonable and valid in time and scope and in all other respects. The covenants set forth in this Agreement shall be considered and construed as separate and independent covenants. Should any part or provision of any covenant be held invalid, void or unenforceable in any court of competent jurisdiction, such invalidity, voidness or unenforceability shall not render invalid, void or unenforceable any other part or provision of this Agreement.

(iii)     Reformation . The parties hereunder agree that it is their intention that the Restrictive Covenants be enforced in accordance with their terms to the maximum extent possible under applicable law. If any portion of the foregoing provisions is found to be invalid or unenforceable by a court of competent jurisdiction, the invalid or unreasonable term shall be redefined, or a new enforceable term provided, such that the intent of the Company and Employee in agreeing to the provisions of this Agreement will not be impaired and the provision in question shall be enforceable to the fullest extent of applicable law.

10.     Publicity and Advertising . The Employee agrees that the Company may use the Employee’s name, picture, or likeness for any advertising, publicity, or other business purpose at any time, during the term of the Agreement by the Company and may continue to use materials generated during the term of the Agreement for a period of 6 months thereafter. The Employee shall receive no additional consideration if the Employee’s name, picture or likeness is so used. The Employee further agrees that any negatives, prints or other material for printing or reproduction purposes prepared in connection with the use of the Employee’s name, picture or likeness by the Company shall be and are the sole property of the Company.

11.     Dispute Resolution . Subject to the Company’s right to seek injunctive relief in court as provided in Section 9 of this Agreement, any dispute, controversy or claim arising out of or in relation to or connection to this Agreement, including without limitation any dispute as to the construction, validity, interpretation, enforceability or breach of this Agreement, including a claim for indemnification under Section 12, shall be resolved either as provided by applicable law, or, at the option of either party, by impartial binding arbitration. In the event that either the Company or the Employee demands arbitration, the Employee and the Company agree that such arbitration shall be the exclusive, final and binding forum for the ultimate resolution of such claims, subject to any rights of appeal that either party may have under the Federal Arbitration Act and/or under applicable state law dealing with the review of arbitration decisions.

(a)     Arbitration . Arbitration shall be heard and determined by one arbitrator, who shall be impartial and who shall be selected by mutual agreement of the parties; provided, however, that if the dispute involves more than $1,000,000, then the arbitration shall be heard and determined by three (3) arbitrators. If three (3) arbitrators are necessary as provided above, then (i) each side shall appoint an arbitrator of its choice within thirty (30) days of the submission of a notice of arbitration and (ii) the party-appointed arbitrators shall in turn appoint a presiding arbitrator of the tribunal within thirty (30) days following the appointment of the last party-appointed arbitrator. If any party fails or refuses to appoint an arbitrator, the arbitration shall proceed with one (1) arbitrator.

(b)     Demand for Arbitration . In the event that the Employee or the Company initially elects to file suit in any court, the other party will have 60 days from the date that it is formally served with a summons and a copy of the suit to notify the party filing the suit of the non-filing party’s demand for arbitration. In that case, the suit must be dismissed by consent of the parties or by the court on motion, and arbitration commenced with the arbitrators. In situations where suit has not been filed, either the Employee or the Company may initiate arbitration by serving a written demand for arbitration upon the other party. Such a demand must be served within twelve months of the events giving rise to the dispute. Any claim that is not timely made will be deemed waived.

(c)     Proceedings . Unless otherwise expressly agreed in writing by the parties to the arbitration proceedings:

(i)    The arbitration proceedings shall be held in Tyler, TX;

(ii)    The arbitrators shall be and remain at all times wholly independent and impartial;

(iii)    The arbitration proceedings shall be conducted in accordance with the Employment Arbitration Rules of the American Arbitration Association, as amended from time to time;

(iv)    Any procedural issues not determined under the arbitral rules selected pursuant to item (iii) above shall be determined by the law of the place of arbitration, other than those laws which would refer the matter to another jurisdiction;


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(v)    The costs of the arbitration proceedings (including attorneys’ fees and costs) shall be borne in the manner determined by the arbitrators;

(vi)    The arbitrators may grant any remedy or relief that would have been available to the parties had the matter been heard in court;

(vii)    The decision of the arbitrators shall be reduced to writing; final and binding without the right of appeal; the sole and exclusive remedy regarding any claims, counterclaims, issues or accounting presented to the arbitrators; made and promptly paid in United States dollars free of any deduction or offset; and any costs or fees incident to enforcing the award shall to the maximum extent permitted by law, be charged against the party resisting such enforcement;

(viii)    The award shall include interest from the date of any breach or violation of this Agreement, as determined by the arbitral award, and from the date of the award until paid in full, at 6% per annum; and

(ix)    Judgment upon the award may be entered in any court having jurisdiction over the person or the assets of the party owing the judgment or application may be made to such court for a judicial acceptance of the award and an order of enforcement, as the case may be.

(d)     Acknowledgment of Parties . The Company and Employee understand and acknowledge that this Agreement means that neither can pursue an action against the other in a court of law regarding any employment dispute, except for claims involving workers’ compensation benefits or unemployment benefits, and except as set forth elsewhere in this Agreement, in the event that either party notifies the other of its demand for arbitration under this Agreement. The Company and Employee understand and agree that this Section 11, concerning arbitration, shall not include any controversies or claims related to any agreements or provisions (including provisions in this Agreement) respecting confidentiality, proprietary information, non-competition, non-solicitation, trade secrets, or breaches of fiduciary obligations by the Employee, which shall not be subject to arbitration.

(e)     Consultation . Employee has been advised of the Employee’s right to consult with an attorney prior to entering into this Agreement.

12.     Indemnification. The Company shall indemnify, defend, protect and hold harmless Employee, from and against all actions, suits or proceedings (whether civil, criminal, administrative, arbitrative or investigative) (collectively, “Proceedings”), and all other claims, demands, losses, damages, liabilities, judgments, awards, penalties, fines, settlements, costs and expenses (including court costs and reasonable attorneys’ fees), arising out of the management of the Company or Employee’s service. This indemnity shall apply to matters that arise out of the negligence, strict liability or other fault or responsibility by Employee, provided however, that this indemnity shall not apply to matters arising out of the gross negligence, willful misconduct, bad faith or intentional breach of this Agreement by Employee.
(a)     Advance Payment . The right to indemnification conferred in Section 12 shall include the right to be paid or reimbursed by the Company the reasonable expenses incurred by Employee who was, is or is threatened to be made a named defendant or respondent in a Proceeding in advance of the final disposition of the Proceeding and without any determination as to Employee’s ultimate entitlement to indemnification; provided, however, that the payment of such expenses incurred by Employee in advance of the final disposition of a Proceeding, shall be made only upon delivery to the Company of a written affirmation by Employee of Employee’s good faith belief that Employee has met the standard of conduct necessary for indemnification under this Section 12 and a written undertaking, by or on behalf of Employee, to repay all amounts so advanced if it shall ultimately be determined that such indemnified Employee is not entitled to be indemnified under this Section 12 or otherwise. The Company shall also pay or reimburse Employee for reasonable expenses in connection with Employee's appearance as a witness or other participation in a Proceeding.

(b)     Nonexclusivity of Rights . The right to indemnification and the advancement and payment of expenses conferred in this Section 12 shall not be exclusive of any other right which Employee, indemnified pursuant to Section 12, may have or hereafter acquire under any Law or Agreement.


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13.     Miscellaneous Provisions .

(a)     Third-Party Beneficiaries . The parties acknowledge and agree that the Company and SBSI, and its direct and indirect subsidiaries and affiliated companies are intended to be beneficiaries of this Agreement and shall have every right to enforce the terms and provisions of this Agreement in accordance with the provisions of this Agreement.

(b)     Successors of the Company . The Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company, by agreement in form and substance satisfactory to the Employee, expressly to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place. Failure of the Company to obtain such agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall entitle the Employee to compensation from the Company in the same amount and on the same terms as the Employee would be entitled hereunder if the Employee terminated her employment for Good Reason in the event of a Change in Control, except that for purposes of implementing the foregoing, the date on which any such succession becomes effective shall be deemed the Date of Termination. As used in this Agreement, “Company” as here in before defined shall include any successor to its business and/or assets as aforesaid which executes and delivers the agreement provided for in this Section 13 or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law.

(c)     Employee’s Heirs, etc . The Employee may not assign the Employee’s rights or delegate the Employee’s duties or obligations hereunder without the written consent of the Company. This Agreement shall inure to the benefit of and be enforceable by the Employee’s personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Employee should die while any amounts would still be payable to the Employee hereunder as if she had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Employee’s designee or, if there be no such designee, to the Employee’s estate.

(d)     Notices . Any notice or communication required or permitted under the terms of this Agreement shall be in writing and shall be delivered personally, or sent by registered or certified mail, return receipt requested, postage prepaid, or sent by nationally recognized overnight carrier, postage prepaid, or sent by facsimile transmission to the Company at the Company’s principal office and facsimile number in Tyler, TX or to the Employee at the address and facsimile number, if any, appearing on the books and records of the Company. Such notice or communication shall be deemed given (a) when delivered if personally delivered; (b) five mailing days after having been placed in the mail, if delivered by registered or certified mail; (c) the business day after having been placed with a nationally recognized overnight carrier, if delivered by nationally recognized overnight carrier, and (d) the business day after transmittal when transmitted with electronic confirmation of receipt, if transmitted by facsimile. Any party may change the address or facsimile number to which notices or communications are to be sent to it by giving notice of such change in the manner herein provided for giving notice. Until changed by notice, the following shall be the address and facsimile number to which notices shall be sent:
If to the Company, to:         Southside Bank
1201 South Beckham
Tyler, Texas 75701

FAX:    903-592-3692
TELE:    903-531-7111

If to the Employee, to:         JULIE SHAMBURGER
3913 Glendale
Tyler, TX 75701

FAX:    903-592-3692
TELE:    903-531-7111

(e)     Amendment or Waiver . No provisions of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing signed by the Employee and such officer as may be specifically designated by the Board (which shall not include the Employee). No waiver by either party hereto at any time of any breach by the other party hereto of or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or

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at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party that are not set forth expressly in this Agreement.

(f)     Invalid Provisions . Should any portion of this Agreement be adjudged or held to be invalid, unenforceable or void, such holding shall not have the effect of invalidating or voiding the remainder of this Agreement and the parties hereby agree that the portion so held invalid, unenforceable or void shall if possible, be deemed amended or reduced in scope, or otherwise be stricken from this Agreement to the extent required for the purposes of validity and enforcement thereof.

(g)     Unreasonable Compensation . If any portion of the Compensation and Benefits provided by this Agreement should be deemed to be unreasonable or disproportionate to the services the Employee provides (under 12 C.F.R. 364 or other applicable law), the Company shall reduce such Compensation and Benefits to the maximum amount that would be reasonable or proportionate.

(h)     Survival of the Employee’s Obligations . The Employee’s obligations under this Agreement shall survive regardless of whether the Employee’s employment by the Company is terminated, voluntarily or involuntarily, by the Company or the Employee, with or without Cause. Employee acknowledges that new, independent and valuable benefits have been received by Employee by virtue of this Agreement and such constitutes consideration for Employee’s agreements herein.

(i)     Counterparts . This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument.

(j)     Governing Law . This Agreement and any action or proceeding related to it shall be governed by and construed under the laws of the State of Texas.

(k)     Captions and Gender . The use of Captions and Section headings herein is for purposes of convenience only and shall not effect the interpretation or substance of any provisions contained herein. Similarly, the use of the masculine gender with respect to pronouns in this Agreement is for purposes of convenience and includes either sex who may be a signatory.

(l)     Effect on Prior Agreements . This Agreement, and any attachments, represent the entire understanding between the parties hereto and supersedes in all respects any other prior Agreement or understanding between the Company and the Employee regarding the Employee’s employment, provided, however, that if the Company determines, after a review of the final regulations issued under Section 409A of the Code and all applicable IRS guidance, that this Agreement should be further amended to avoid triggering the tax and interest penalties imposed by Section 409A of the Code, the Company may amend this Agreement to the extent necessary to avoid triggering the tax and interest penalties imposed by Section 409A of the Code.

(m)     Independent Consideration. Employee acknowledges that this Agreement is fully supported by new and independent consideration to Employee and fully meets the requirements of Texas laws as they relate to employment agreements that contain non-compensation agreements. Employee agrees to all of the terms of this Agreement as part of receiving the new and independent consideration extended to Employee under this Agreement.


IN WITNESS WHEREOF, the Employee and a duly authorized Company officer have signed this Agreement as of the date first written above.
        
THE EMPLOYEE:
SOUTHSIDE BANK
 
 
/s/ Julie Shamburger
By:
/s/ B.G. Hartley
 
 
JULIE SHAMBURGER
Title:
 Chairman and CEO
 
 


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DEFERRED COMPEN SATION AGREEMENT


THIS AGREEMENT is entered into, effective as of the date executed, by and between SOUTHSIDE BANK, a corporation organized and existing under the laws of the State of Texas, hereinafter called BANK, and TIM ALEXANDER, hereinafter called EXECUTIVE.

W I T N E S S E T H:

I.

The Board of Directors of BANK have determined that the service of EXECUTIVE to BANK since employment of EXECUTIVE has been of exceptional merit and has constituted an invaluable contribution to the general welfare of BANK. The Board of Directors has further determined that the continued service of EXECUTIVE on behalf of BANK is essential to the future growth and profit of BANK and it is in the best interest of BANK to arrange for financial incentives for EXECUTIVE to remain in the employment of BANK for the balance of his work lifetime.

II.

BANK agrees to employ EXECUTIVE in such capacity as BANK may from time to time determine. EXECUTIVE will continue in the employment of BANK in such capacity and with such duties and responsibilities as may from time to time be assigned to such EXECUTIVE. BANK shall have sole discretion over compensation to be paid to EXECUTIVE for the performance of such services. EXECUTIVE agrees to well and truly perform his duties and obligations as an employee of BANK and will use his best efforts to furnish faithful and satisfactory services to BANK. Nothing in this Agreement shall be construed as any limitation of the BANK's right and privilege to discontinue the employment of the EXECUTIVE at any time, subject to the deferred compensation provisions set forth in this Agreement.

III.

It is specifically agreed that if EXECUTIVE remains in the employment of BANK until his disability, death, or attainment of age 65, whichever occurs first, BANK agrees to pay the sum of THREE HUNDRED THOUSAND AND NO/100 DOLLARS ($300,000.00) to EXECUTIVE or his surviving spouse or designated beneficiaries as hereinafter provided. Such deferred compensation shall be payable commencing on the 1st day of the month following the first of the following events to occur while EXECUTIVE is employed by the BANK:

A.    The disability of EXECUTIVE. For purposes of this Agreement, disability shall mean that EXECUTIVE, by reason of any medically determinable physical or mental impairment that can be expected to result in death or can be expected to last for a continuous period of not less than 12 months, is receiving income replacement benefits for a period of not less than three months under an accident or health plan covering employees of the BANK or, in the absence of such a plan, is determined to be totally and permanently disabled by the Social Security Administration;

B.    The EXECUTIVE’S separation from service with the Bank after attainment of age 65; or

C.    The death of EXECUTIVE,

Deferred compensation, when it commences, shall be payable in 120 equal consecutive monthly installments of TWO THOUSAND FIVE HUNDRED DOLLARS ($2,500.00) each.

IV.

EXECUTIVE shall have the right to name a beneficiary other than his spouse, provided, such designation of beneficiary be in writing and signed by EXECUTIVE and EXECUTIVE'S spouse, and delivered to BANK. Such designation of beneficiary may provide for alternative beneficiaries if the designated beneficiary fails to survive EXECUTIVE or fails to survive the term of payout, as provided above. Failure to designate a beneficiary in accordance with the terms hereof shall be deemed an election by EXECUTIVE that such benefit as provided herein shall go to the surviving spouse or, should the EXECUTIVE'S spouse die simultaneously or predecease him or die during the term of the payment of benefits, to his then surviving children in equal portions.



LEGAL02/31063425v1 1
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V.

If EXECUTIVE should die prior to age 65 or disability and such death is the result of a suicide, the death benefits provided in this Agreement shall not be payable unless such suicide occurs after the lapsing of any anti-suicide provisions contained in any insurance policy purchased by BANK upon the life of EXECUTIVE, should BANK so elect to purchase such insurance for its own benefit. If there is no policy, no death benefit shall be payable if death is the result of a suicide.

VI.

If for any reason other than good cause, EXECUTIVE'S employment is involuntarily terminated by BANK, such termination shall not terminate this Agreement and shall be deemed to be the same as a separation from service after attainment of age 65 for purposes of this Agreement. For the purposes of this Agreement, "good cause" shall be defined as action or inaction equivalent to habitual dereliction of duty, gross insubordination, willful misconduct, criminal conduct, gross negligence, or willful or malicious violation of federal or state banking statutes with the intent by the EXECUTIVE to derive personal financial benefit or to do financial harm to the Bank.

VII.

If, prior to a Change in Control, EXECUTIVE terminates employment (as contrasted with termination initiated by BANK) prior to attainment of age 65 for any reason other than death or disability, no amounts shall be due EXECUTIVE under this Agreement. If, after a Change in Control, the EXECUTIVE terminates employment (as contrasted with termination initiated by BANK) prior to attainment of age 65 for any reason other than death, disability, or good reason, no amounts shall be due EXECUTIVE under this Agreement. After a Change in Control, a termination for good reason shall be deemed the same as involuntary termination by the BANK for the purposes of this Agreement. For purposes of this Agreement "good reason" shall mean that the EXECUTIVE resigns from his position(s) with the BANK after the occurrence of any of the following as determined by the EXECUTIVE in good faith:

(i)    Without his express written consent, the assignment to the EXECUTIVE of any duties that are clearly inconsistent with his positions, duties, responsibilities and status with the BANK as in effect immediately before the execution of this Agreement or a detrimental change in his titles or offices as in effect immediately before execution of this Agreement, or any removal of the EXECUTIVE from or any failures to re-elect the EXECUTIVE to any of such positions, except in connection with the termination of his employment for good cause or as a result of his disability or death;

(ii)    A reduction of the EXECUTIVE'S base salary or overall compensation (other than as a result of year to year variations in bonuses consistent with past practices or consistent with the similar reductions applied to the BANK's entire workforce) without the prior written consent of the EXECUTIVE;

(iii)    The BANK shall relocate its principal executive offices or require EXECUTIVE to have as his principal location of work any location which is in excess of thirty (30) miles from the current location of the BANK or to travel away from his office in the course of discharging his responsibilities or duties hereunder more than thirty (30) consecutive calendar days or an aggregate of more than ninety (90) calendar days in any consecutive three hundred sixty-five (365) calendar-day period without in either case his prior consent; or

(v)    Failure by the BANK to require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the BANK, by agreement in form and substance satisfactory to the EXECUTIVE, expressly to assume and agree to perform this Agreement in the same manner and to the same extent that the BANK would be required to perform it if no such succession had taken place.

(vi)    As a result of a Change in Control of the BANK or of Southside Bancshares, Inc. ("BHC") and a change in circumstances thereafter significantly affecting his position, the EXECUTIVE is rendered substantially unable to carry out, or has been substantially hindered in the performance of, any of the authorities, powers, functions, responsibilities or duties attached to his position immediately prior to the Change in Control of the BANK, which situation is not remedied within thirty (30) calendar days after receipt by the BANK of written notice from the EXECUTIVE of such determination. For purposes of this section, a "Change in Control" shall be deemed to have occurred in the event of any of the following:

(1)    a change in the ownership of the capital stock of the BANK where a corporation, person or group acting in concert (a "Person") as described in Section 14(d)(2) of the Securities Exchange Act of 1934,

LEGAL02/31063425v1 2
2


as amended (the "Exchange Act"), holds or acquires, directly or indirectly, beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of a number of shares of capital stock of the BANK or of BHC which constitutes 50% or more of the combined voting power of the BANK's (or BHC's) then outstanding capital stock then entitled to vote generally in the election of directors; or

(2)    the persons who were members of the Board of Directors of the BANK or BHC immediately prior to a tender offer, exchange offer, contested election or any combination of the foregoing, cease to constitute a majority of the Board of Directors; or

(3)    the adoption by the Board of Directors of the BANK or of the BHC of a merger, consolidation or reorganization plan involving the BANK in which the BANK or BHC is not the surviving entity, or a sale of all or substantially all of the assets of the BANK or BHC. For purposes of this Agreement, a sale of all or substantially all of the assets of the BANK or BHC shall be deemed to occur if any Person acquires (or during the 12-month period ending on the date of the most recent acquisition by such Person, has acquired) gross assets of the BANK or BHC that have an aggregate fair market value equal to 50% of the fair market value of all of the gross assets of the BANK or BHC immediately prior to such acquisition or acquisitions; or

(4)    a tender offer or exchange offer is made by any Person which, if successfully completed, would result in such Person beneficially owning (within the meaning of Rule 13d-3 promulgated under the Exchange Act) either 50% or more of the BANK's or BHC's outstanding shares of Common Stock or shares of capital stock having 50% or more of the combined voting power of the BANK's or BHC's then outstanding capital stock (other than an offer made by the BANK or BHC), and sufficient shares are acquired under the offer to cause such person to own 50% or more of the voting power; or

(5)    any other transactions or series of related transactions occurring which have substantially the same effect as the transactions specified in any of the preceding clauses of this subsection (vi).

(vii)    The BANK's failure to perform any material provision of this Agreement.

(viii)    Any requirement by the BANK or the Board of Directors of the BANK that the EXECUTIVE perform, assist, abet or approve any act which is or could be construed to be illegal under any federal, state or local law.

VIII.

Neither EXECUTIVE nor any beneficiary of EXECUTIVE shall have any power or right to transfer, assign, anticipate, mortgage, commute or otherwise encumber in advance any of the benefits payable hereunder, nor shall such benefits be subject to seizure for payment of any debts or judgments of EXECUTIVE or beneficiaries, nor shall such benefits be transferable by operation of law in the event of bankruptcy, insolvency or otherwise.

IX.

The BANK shall have no obligation to set aside, earmark or entrust any fund or money with which to pay its obligations under this Agreement. The EXECUTIVE, his Beneficiary or any successor-in-interest to him shall be and remain simply a general creditor of the BANK in the same manner as any other creditor having a general unsecured claim.

For purposes of the Internal Revenue Code, the BANK intends this Agreement to be an unfunded, unsecured promise to pay on the part of the BANK. For purposes of ERISA, the BANK intends that this Agreement be an unfunded arrangement for the benefit of a select member of management, who is a highly compensated employee of the BANK for the purpose of qualifying this Agreement for the "top hat" plan exception under sections 201(2), 301(a)(3) and 401(a)(1) of ERISA. "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended.

Should the BANK elect to satisfy its obligations under this Agreement, in whole or in part, through the purchase of life insurance, mutual funds, disability policies or annuities, the BANK reserves the absolute right, in its sole discretion, to terminate such at any time, in whole or in part. Any such funding shall in no event affect EXECUTIVE'S rights and it is not intended that any BANK asset be segregated or considered a plan asset. At no time shall the EXECUTIVE have or be deemed to have any lien nor right, title or interest in or to any specific investment or to any assets of the BANK; rather the EXECUTIVE shall remain a general unsecured creditor of the BANK.


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3


If the BANK elects to invest in a life insurance, disability or annuity policy upon the life of EXECUTIVE, the EXECUTIVE shall assist the BANK by freely submitting to a physical exam and supplying such additional information necessary to obtain such insurance or annuities.

X.

The Board of Directors of the BANK shall have the exclusive power and authority to interpret and construe the Agreement. The Board of Directors of the BANK may engage agents to assist it and may engage legal counsel, who may be counsel to the BANK. The Agreement may be amended, suspended or terminated, in whole or in part, only by a written instrument signed by a duly authorized officer of the BANK and by EXECUTIVE.

XI.

Whenever in this Agreement words are used in the masculine or neuter gender, they shall be read and construed as in the masculine, feminine or neuter gender, whenever they should so apply.

Nothing contained in this Agreement shall affect the right of the EXECUTIVE to participate in or be covered by any qualified or non-qualified pension, profit sharing, group, bonus or other supplemental compensation or fringe benefit plan constituting a part of the BANK's existing or future compensation structure.

The validity and interpretation of this Agreement shall be governed by the laws of the State of Texas or Federal laws, where applicable.

No provision of this Agreement shall be deemed or construed to create specific employment rights to the EXECUTIVE nor limit the right of the BANK to discharge the EXECUTIVE at any time with or without cause. In a similar fashion, no provision shall limit the EXECUTIVE'S rights to voluntarily sever his employment at any time.

The BANK shall deduct from the amount of any payment made pursuant to this Agreement any amounts required to be paid or withheld by the BANK with respect to federal or state taxes. By executing this Agreement, the EXECUTIVE agrees to all such deductions.

In case any one or more of the provisions contained in this Agreement shall be invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions in this Agreement shall not in any way be affected or impaired.

XII.

In the event of any claim or controversy arising out of or relating to this Agreement or the breach of this Agreement, the parties agree that all such claims or controversies shall be resolved by final and binding arbitration in Smith County, Texas, in accordance with the Commercial Arbitration Rules of the American Arbitration Association in effect on the date when the claim or controversy first arises. Either party must communicate its request for arbitration under this section in writing ("Arbitration Notice") to the other party within one hundred twenty (120) days from the date the claim or controversy first arises. Failure to communicate Arbitration Notice within one hundred twenty (120) days shall constitute a waiver of any such claim or controversy.

All claims or controversies subject to arbitration under this section shall be submitted to an arbitration hearing within thirty (30) days from the date Arbitration Notice is communicated by either party. All claims or controversies submitted to arbitration under this section shall be resolved by a panel of three (3) arbitrators who are licensed to practice law in the State of Texas and who are experienced in the arbitration of employment disputes. These arbitrators shall be selected in accordance with the applicable Commercial Arbitration Rules or by agreement of the parties. Either party may request that the arbitration proceeding be stenographically recorded by a Certified Shorthand Reporter. The arbitrators shall issue a decision on any claim or controversy within thirty (30) days from the date the arbitration hearing is completed. The parties shall have the right to be represented by legal counsel at any arbitration hearing. The costs of any arbitration hearing, including the attorneys' fees incurred by both parties (including any costs, expenses or attorneys' fees incurred in filing any lawsuit to compel arbitration under this section, if applicable), shall be paid by the losing party or parties.

The arbitration provisions in this section are subject to the Federal Arbitration Act, 9 U.S.C. Sections 1 et seq. (West 1994) (or any successor provisions) and may be specifically enforced by any party, and submission to arbitration proceedings compelled, by any Court of competent jurisdiction. The decision of the arbitrators may be specifically enforced by any party in any court of competent jurisdiction.

LEGAL02/31063425v1 4
4



XIII.

This Agreement is intended to comply with Section 409A of the Internal Revenue Code (“Section 409A”) to the extent applicable and shall be so interpreted. Any references to Section 409A shall refer to such Section and regulations and guidance thereunder as applicable and as they may be amended from time to time. Notwithstanding anything in the Agreement to the contrary, for purposes of determining when an amount is to be paid under the Agreement, a “separation from service” shall mean a “separation from service” as defined under Section 409A. Notwithstanding anything in the Agreement to the contrary, if distributions would otherwise be payable due to the separation from service of the EXECUTIVE during a period when the EXECUTIVE is a specified employee (as defined below), then, to the extent required by Section 409A, and subject to any permitted accelerations under Section 409A, including acceleration permitted under Treas. Reg. Section 1.409A-3(j)(4)(ii)(domestic relations orders), (j)(4)(iii)(conflicts of interest), or (j)(4)(vi) (payment of employment taxes), such distributions may not commence earlier than the participant’s death or six (6) months after the date of the separation from service.  The first six (6) months of installment payments shall be accumulated and paid instead on the first day of the seventh month following the separation from service. Any installment payments due thereafter shall be made on their regular schedule. BANK’s specified employees shall be determined in accordance with Section 409A pursuant to rules adopted by the BANK, which rules shall be applied consistently with respect to all arrangements of the Bank in accordance with Section 409A.

XIV.

This Agreement shall be binding upon and inure to the benefit of EXECUTIVE, his heirs and personal representative, and BANK and its successors and assigns and supersedes all prior agreements between EXECUTIVE and BANK regarding deferred compensation. It is specifically agreed that this is not a contract of employment between the parties hereto and nothing herein shall restrict the right of BANK to discharge EXECUTIVE, with or without cause, or restrict the right of EXECUTIVE to terminate his employment. However, termination of employment by EXECUTIVE prior to retirement for any reason not specifically entitling EXECUTIVE to compensation under the preceding terms of this Agreement shall terminate all obligations of BANK hereunder.


 
 
EXECUTED this 12 th  day of December, 2008
 
 
 
 
 
 
 
 
 
 
 
 
 
 
/s/ Tim Alexander
 
 
 
TIM ALEXANDER, EXECUTIVE
 
 
 
 
 
 
 
 
 
 
 
 
SOUTHSIDE BANK
 
 
 
 
 
 
 
 
 
 
BY:
/s/ B.G. Hartley
 
 
 
B.G. HARTLEY, CHAIRMAN OF THE BOARD And CHIEF EXECUTIVE OFFICER
ATTEST:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


LEGAL02/31063425v1 5
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DEFERRED COMPENSATION AGREEMENT


THIS AGREEMENT is entered into, effective as of the date executed, by and between SOUTHSIDE BANK, a corporation organized and existing under the laws of the State of Texas, hereinafter called BANK, and JULIE SHAMBURGER, hereinafter called EXECUTIVE.

W I T N E S S E T H:

I.

The Board of Directors of BANK have determined that the service of EXECUTIVE to BANK since employment of EXECUTIVE has been of exceptional merit and has constituted an invaluable contribution to the general welfare of BANK. The Board of Directors has further determined that the continued service of EXECUTIVE on behalf of BANK is essential to the future growth and profit of BANK and it is in the best interest of BANK to arrange for financial incentives for EXECUTIVE to remain in the employment of BANK for the balance of his work lifetime.

II.

BANK agrees to employ EXECUTIVE in such capacity as BANK may from time to time determine. EXECUTIVE will continue in the employment of BANK in such capacity and with such duties and responsibilities as may from time to time be assigned to such EXECUTIVE. BANK shall have sole discretion over compensation to be paid to EXECUTIVE for the performance of such services. EXECUTIVE agrees to well and truly perform his duties and obligations as an employee of BANK and will use his best efforts to furnish faithful and satisfactory services to BANK. Nothing in this Agreement shall be construed as any limitation of the BANK's right and privilege to discontinue the employment of the EXECUTIVE at any time, subject to the deferred compensation provisions set forth in this Agreement.

III.

It is specifically agreed that if EXECUTIVE remains in the employment of BANK until his disability, death, or attainment of age 65, whichever occurs first, BANK agrees to pay the sum of THREE HUNDRED THOUSAND AND NO/100 DOLLARS ($300,000.00) to EXECUTIVE or his surviving spouse or designated beneficiaries as hereinafter provided. Such deferred compensation shall be payable commencing on the 1st day of the month following the first of the following events to occur while EXECUTIVE is employed by the BANK:

A.    The disability of EXECUTIVE. For purposes of this Agreement, disability shall mean that EXECUTIVE, by reason of any medically determinable physical or mental impairment that can be expected to result in death or can be expected to last for a continuous period of not less than 12 months, is receiving income replacement benefits for a period of not less than three months under an accident or health plan covering employees of the BANK or, in the absence of such a plan, is determined to be totally and permanently disabled by the Social Security Administration;

B.    The EXECUTIVE’S separation from service with the Bank after attainment of age 65; or

C.    The death of EXECUTIVE,

Deferred compensation, when it commences, shall be payable in 120 equal consecutive monthly installments of TWO THOUSAND FIVE HUNDRED DOLLARS ($2,500.00) each.

IV.

EXECUTIVE shall have the right to name a beneficiary other than his spouse, provided, such designation of beneficiary be in writing and signed by EXECUTIVE and EXECUTIVE'S spouse, and delivered to BANK. Such designation of beneficiary may provide for alternative beneficiaries if the designated beneficiary fails to survive EXECUTIVE or fails to survive the term of payout, as provided above. Failure to designate a beneficiary in accordance with the terms hereof shall be deemed an election by EXECUTIVE that such benefit as provided herein shall go to the surviving spouse or, should the EXECUTIVE'S spouse die simultaneously or predecease him or die during the term of the payment of benefits, to his then surviving children in equal portions.



LEGAL02/31063425v1
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V.

If EXECUTIVE should die prior to age 65 or disability and such death is the result of a suicide, the death benefits provided in this Agreement shall not be payable unless such suicide occurs after the lapsing of any anti-suicide provisions contained in any insurance policy purchased by BANK upon the life of EXECUTIVE, should BANK so elect to purchase such insurance for its own benefit. If there is no policy, no death benefit shall be payable if death is the result of a suicide.

VI.

If for any reason other than good cause, EXECUTIVE'S employment is involuntarily terminated by BANK, such termination shall not terminate this Agreement and shall be deemed to be the same as a separation from service after attainment of age 65 for purposes of this Agreement. For the purposes of this Agreement, "good cause" shall be defined as action or inaction equivalent to habitual dereliction of duty, gross insubordination, willful misconduct, criminal conduct, gross negligence, or willful or malicious violation of federal or state banking statutes with the intent by the EXECUTIVE to derive personal financial benefit or to do financial harm to the Bank.

VII.

If, prior to a Change in Control, EXECUTIVE terminates employment (as contrasted with termination initiated by BANK) prior to attainment of age 65 for any reason other than death or disability, no amounts shall be due EXECUTIVE under this Agreement. If, after a Change in Control, the EXECUTIVE terminates employment (as contrasted with termination initiated by BANK) prior to attainment of age 65 for any reason other than death, disability, or good reason, no amounts shall be due EXECUTIVE under this Agreement. After a Change in Control, a termination for good reason shall be deemed the same as involuntary termination by the BANK for the purposes of this Agreement. For purposes of this Agreement "good reason" shall mean that the EXECUTIVE resigns from his position(s) with the BANK after the occurrence of any of the following as determined by the EXECUTIVE in good faith:

(i)    Without his express written consent, the assignment to the EXECUTIVE of any duties that are clearly inconsistent with his positions, duties, responsibilities and status with the BANK as in effect immediately before the execution of this Agreement or a detrimental change in his titles or offices as in effect immediately before execution of this Agreement, or any removal of the EXECUTIVE from or any failures to re-elect the EXECUTIVE to any of such positions, except in connection with the termination of his employment for good cause or as a result of his disability or death;

(ii)    A reduction of the EXECUTIVE'S base salary or overall compensation (other than as a result of year to year variations in bonuses consistent with past practices or consistent with the similar reductions applied to the BANK's entire workforce) without the prior written consent of the EXECUTIVE;

(iii)    The BANK shall relocate its principal executive offices or require EXECUTIVE to have as his principal location of work any location which is in excess of thirty (30) miles from the current location of the BANK or to travel away from his office in the course of discharging his responsibilities or duties hereunder more than thirty (30) consecutive calendar days or an aggregate of more than ninety (90) calendar days in any consecutive three hundred sixty-five (365) calendar-day period without in either case his prior consent; or

(v)    Failure by the BANK to require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the BANK, by agreement in form and substance satisfactory to the EXECUTIVE, expressly to assume and agree to perform this Agreement in the same manner and to the same extent that the BANK would be required to perform it if no such succession had taken place.

(vi)    As a result of a Change in Control of the BANK or of Southside Bancshares, Inc. ("BHC") and a change in circumstances thereafter significantly affecting his position, the EXECUTIVE is rendered substantially unable to carry out, or has been substantially hindered in the performance of, any of the authorities, powers, functions, responsibilities or duties attached to his position immediately prior to the Change in Control of the BANK, which situation is not remedied within thirty (30) calendar days after receipt by the BANK of written notice from the EXECUTIVE of such determination. For purposes of this section, a "Change in Control" shall be deemed to have occurred in the event of any of the following:

(1)    a change in the ownership of the capital stock of the BANK where a corporation, person or group acting in concert (a "Person") as described in Section 14(d)(2) of the Securities Exchange Act of 1934,

LEGAL02/31063425v1
2


as amended (the "Exchange Act"), holds or acquires, directly or indirectly, beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of a number of shares of capital stock of the BANK or of BHC which constitutes 50% or more of the combined voting power of the BANK's (or BHC's) then outstanding capital stock then entitled to vote generally in the election of directors; or

(2)    the persons who were members of the Board of Directors of the BANK or BHC immediately prior to a tender offer, exchange offer, contested election or any combination of the foregoing, cease to constitute a majority of the Board of Directors; or

(3)    the adoption by the Board of Directors of the BANK or of the BHC of a merger, consolidation or reorganization plan involving the BANK in which the BANK or BHC is not the surviving entity, or a sale of all or substantially all of the assets of the BANK or BHC. For purposes of this Agreement, a sale of all or substantially all of the assets of the BANK or BHC shall be deemed to occur if any Person acquires (or during the 12-month period ending on the date of the most recent acquisition by such Person, has acquired) gross assets of the BANK or BHC that have an aggregate fair market value equal to 50% of the fair market value of all of the gross assets of the BANK or BHC immediately prior to such acquisition or acquisitions; or

(4)    a tender offer or exchange offer is made by any Person which, if successfully completed, would result in such Person beneficially owning (within the meaning of Rule 13d-3 promulgated under the Exchange Act) either 50% or more of the BANK's or BHC's outstanding shares of Common Stock or shares of capital stock having 50% or more of the combined voting power of the BANK's or BHC's then outstanding capital stock (other than an offer made by the BANK or BHC), and sufficient shares are acquired under the offer to cause such person to own 50% or more of the voting power; or

(5)    any other transactions or series of related transactions occurring which have substantially the same effect as the transactions specified in any of the preceding clauses of this subsection (vi).

(vii)    The BANK's failure to perform any material provision of this Agreement.

(viii)    Any requirement by the BANK or the Board of Directors of the BANK that the EXECUTIVE perform, assist, abet or approve any act which is or could be construed to be illegal under any federal, state or local law.

VIII.

Neither EXECUTIVE nor any beneficiary of EXECUTIVE shall have any power or right to transfer, assign, anticipate, mortgage, commute or otherwise encumber in advance any of the benefits payable hereunder, nor shall such benefits be subject to seizure for payment of any debts or judgments of EXECUTIVE or beneficiaries, nor shall such benefits be transferable by operation of law in the event of bankruptcy, insolvency or otherwise.

IX.

The BANK shall have no obligation to set aside, earmark or entrust any fund or money with which to pay its obligations under this Agreement. The EXECUTIVE, his Beneficiary or any successor-in-interest to him shall be and remain simply a general creditor of the BANK in the same manner as any other creditor having a general unsecured claim.

For purposes of the Internal Revenue Code, the BANK intends this Agreement to be an unfunded, unsecured promise to pay on the part of the BANK. For purposes of ERISA, the BANK intends that this Agreement be an unfunded arrangement for the benefit of a select member of management, who is a highly compensated employee of the BANK for the purpose of qualifying this Agreement for the "top hat" plan exception under sections 201(2), 301(a)(3) and 401(a)(1) of ERISA. "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended.

Should the BANK elect to satisfy its obligations under this Agreement, in whole or in part, through the purchase of life insurance, mutual funds, disability policies or annuities, the BANK reserves the absolute right, in its sole discretion, to terminate such at any time, in whole or in part. Any such funding shall in no event affect EXECUTIVE'S rights and it is not intended that any BANK asset be segregated or considered a plan asset. At no time shall the EXECUTIVE have or be deemed to have any lien nor right, title or interest in or to any specific investment or to any assets of the BANK; rather the EXECUTIVE shall remain a general unsecured creditor of the BANK.


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If the BANK elects to invest in a life insurance, disability or annuity policy upon the life of EXECUTIVE, the EXECUTIVE shall assist the BANK by freely submitting to a physical exam and supplying such additional information necessary to obtain such insurance or annuities.

X.

The Board of Directors of the BANK shall have the exclusive power and authority to interpret and construe the Agreement. The Board of Directors of the BANK may engage agents to assist it and may engage legal counsel, who may be counsel to the BANK. The Agreement may be amended, suspended or terminated, in whole or in part, only by a written instrument signed by a duly authorized officer of the BANK and by EXECUTIVE.

XI.

Whenever in this Agreement words are used in the masculine or neuter gender, they shall be read and construed as in the masculine, feminine or neuter gender, whenever they should so apply.

Nothing contained in this Agreement shall affect the right of the EXECUTIVE to participate in or be covered by any qualified or non-qualified pension, profit sharing, group, bonus or other supplemental compensation or fringe benefit plan constituting a part of the BANK's existing or future compensation structure.

The validity and interpretation of this Agreement shall be governed by the laws of the State of Texas or Federal laws, where applicable.

No provision of this Agreement shall be deemed or construed to create specific employment rights to the EXECUTIVE nor limit the right of the BANK to discharge the EXECUTIVE at any time with or without cause. In a similar fashion, no provision shall limit the EXECUTIVE'S rights to voluntarily sever his employment at any time.

The BANK shall deduct from the amount of any payment made pursuant to this Agreement any amounts required to be paid or withheld by the BANK with respect to federal or state taxes. By executing this Agreement, the EXECUTIVE agrees to all such deductions.

In case any one or more of the provisions contained in this Agreement shall be invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions in this Agreement shall not in any way be affected or impaired.

XII.

In the event of any claim or controversy arising out of or relating to this Agreement or the breach of this Agreement, the parties agree that all such claims or controversies shall be resolved by final and binding arbitration in Smith County, Texas, in accordance with the Commercial Arbitration Rules of the American Arbitration Association in effect on the date when the claim or controversy first arises. Either party must communicate its request for arbitration under this section in writing ("Arbitration Notice") to the other party within one hundred twenty (120) days from the date the claim or controversy first arises. Failure to communicate Arbitration Notice within one hundred twenty (120) days shall constitute a waiver of any such claim or controversy.

All claims or controversies subject to arbitration under this section shall be submitted to an arbitration hearing within thirty (30) days from the date Arbitration Notice is communicated by either party. All claims or controversies submitted to arbitration under this section shall be resolved by a panel of three (3) arbitrators who are licensed to practice law in the State of Texas and who are experienced in the arbitration of employment disputes. These arbitrators shall be selected in accordance with the applicable Commercial Arbitration Rules or by agreement of the parties. Either party may request that the arbitration proceeding be stenographically recorded by a Certified Shorthand Reporter. The arbitrators shall issue a decision on any claim or controversy within thirty (30) days from the date the arbitration hearing is completed. The parties shall have the right to be represented by legal counsel at any arbitration hearing. The costs of any arbitration hearing, including the attorneys' fees incurred by both parties (including any costs, expenses or attorneys' fees incurred in filing any lawsuit to compel arbitration under this section, if applicable), shall be paid by the losing party or parties.

The arbitration provisions in this section are subject to the Federal Arbitration Act, 9 U.S.C. Sections 1 et seq. (West 1994) (or any successor provisions) and may be specifically enforced by any party, and submission to arbitration proceedings compelled, by any Court of competent jurisdiction. The decision of the arbitrators may be specifically enforced by any party in any court of competent jurisdiction.

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XIII.

This Agreement is intended to comply with Section 409A of the Internal Revenue Code (“Section 409A”) to the extent applicable and shall be so interpreted. Any references to Section 409A shall refer to such Section and regulations and guidance thereunder as applicable and as they may be amended from time to time. Notwithstanding anything in the Agreement to the contrary, for purposes of determining when an amount is to be paid under the Agreement, a “separation from service” shall mean a “separation from service” as defined under Section 409A. Notwithstanding anything in the Agreement to the contrary, if distributions would otherwise be payable due to the separation from service of the EXECUTIVE during a period when the EXECUTIVE is a specified employee (as defined below), then, to the extent required by Section 409A, and subject to any permitted accelerations under Section 409A, including acceleration permitted under Treas. Reg. Section 1.409A-3(j)(4)(ii)(domestic relations orders), (j)(4)(iii)(conflicts of interest), or (j)(4)(vi) (payment of employment taxes), such distributions may not commence earlier than the participant’s death or six (6) months after the date of the separation from service.  The first six (6) months of installment payments shall be accumulated and paid instead on the first day of the seventh month following the separation from service. Any installment payments due thereafter shall be made on their regular schedule. BANK’s specified employees shall be determined in accordance with Section 409A pursuant to rules adopted by the BANK, which rules shall be applied consistently with respect to all arrangements of the Bank in accordance with Section 409A.

XIV.

This Agreement shall be binding upon and inure to the benefit of EXECUTIVE, his heirs and personal representative, and BANK and its successors and assigns and supersedes all prior agreements between EXECUTIVE and BANK regarding deferred compensation. It is specifically agreed that this is not a contract of employment between the parties hereto and nothing herein shall restrict the right of BANK to discharge EXECUTIVE, with or without cause, or restrict the right of EXECUTIVE to terminate his employment. However, termination of employment by EXECUTIVE prior to retirement for any reason not specifically entitling EXECUTIVE to compensation under the preceding terms of this Agreement shall terminate all obligations of BANK hereunder.


 
 
EXECUTED this 12 th  day of December, 2008
 
 
 
 
 
 
 
 
 
 
 
 
 
 
/s/ Julie Shamburger
 
 
 
 
JULIE SHAMBURGER, EXECUTIVE
 
 
 
 
 
 
 
 
 
 
 
 
SOUTHSIDE BANK
 
 
 
 
 
 
 
 
 
 
BY:
/s/ B.G. Hartley
 
 
 
 
B.G. HARTLEY, CHAIRMAN OF THE BOARD And CHIEF EXECUTIVE OFFICER
ATTEST:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


LEGAL02/31063425v1
5
Exhibit 31.1

Certification of Chief Executive Officer


I, Lee R. Gibson, certify that:
1.
I have reviewed this Quarterly Report on Form 10-Q of Southside Bancshares, Inc.;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a.
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b.
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c.
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d.
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
a.
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b.
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date:
April 28, 2017
By:
/s/ LEE R. GIBSON
 
 
 
Lee R. Gibson, CPA
 
 
 
President and Chief Executive Officer
 


Exhibit 31.2

Certification of Chief Financial Officer


I, Julie N. Shamburger, certify that:
1.
I have reviewed this Quarterly Report on Form 10-Q of Southside Bancshares, Inc.;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a.
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b.
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c.
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d.
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
a.
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b.
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date:
April 28, 2017
By:
/s/ JULIE N. SHAMBURGER
 
 
 
Julie N. Shamburger, CPA
 
 
 
Executive Vice President and Chief Financial Officer


 
 



Exhibit 32

Certification of Chief Executive and Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the filing of the Quarterly Report on Form 10-Q for the period ended March 31, 2017 (the “Report”) by Southside Bancshares, Inc. (“Registrant”), each of the undersigned hereby certifies that to his or her knowledge:

1.
The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and
2.
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Registrant.
 
Date:
April 28, 2017
By:
/s/ LEE R. GIBSON
 
 
 
Lee R. Gibson, CPA
 
 
 
President and Chief Executive Officer
 
 
 
 
Date:
April 28, 2017
By:
/s/ JULIE N. SHAMBURGER
 
 
 
Julie N. Shamburger, CPA
 
 
 
Executive Vice President and Chief Financial Officer